How are Stock Prices Determined
How stock prices are determined is not an exact science in reality, although we can in theory understand what causes prices to move up or down. You have probably learned that a great deal of money can be made trading stocks, and want to know more about it.
Naturally, you might want to try your hand at stock trading. Before you can make money trading stocks, however, you will need to understand how they work and what makes prices move up or down. Understanding how stock prices are determined will allow you to see opportunities when they arise and take advantage of them quickly.
So what causes one stock to rise and break records while another flounders? In this quick guide, we will discover the ins and outs of what factors impact stock prices.
How It All Begins - The IPO
In the beginning, when a company first decides to ‘go public’ or open up to outside investors, it must go through a rigorous process which can last years, ensuring that is suitable for public offering.
Eventually, when it has been determined that the company can be taken public, a team of expert analysts, exchange commissioners, investors, and investment bankers, will get together and try to determine an IPO, also known as an initial public offering.
The IPO is decided in a way which is far too complex to detail in this article, but it can involve bankers comparing the company in question to another company trading on the market, and will almost certainly involve an independent team of financial analysts who will attempt to determine the company’s health and overall value.
When this has been done and an IPO price has been reached, it will be up to the exchange to have the final say on whether or not the price is fair.
When it does, the company will be brought to market at that value. IPOs are often exciting times and some companies see their stock price initially skyrocket before later settling down and reaching an equilibrium.
When Market Forces Take Over
After the hype and excitement of the IPO, the stock price will be determined mostly by supply and demand.
Put simply, when more people demand a stock in a company, say because it is performing well and making killer profits, then the price rises, since there are only a set number of shares.
Likewise, when a company is underperforming, hemorrhaging money and failing to make the kinds of profits investors desire, the stock price falls as investors sell their shares, and fewer people want to buy them.
It’s supply and demand - plain and simple. This fundamental force will largely determine a stock price for the rest of its existence.
Buy orders are an offer to buy. Investors may believe that a company is going to perform well in and around earnings season, or at any time for that matter, and want to buy. This is also called the bid.
Sell orders are just the opposite. Think about it, if you held stock in company X, and you believed they were about to announce a loss, you would likely sell either before that loss was announced or shortly after it, since the stock will be worth less soon. This is also called the ask.
The price of a stock at any given moment is determined by finding the price at which the maximum number of shares will be traded. After this is determined, those transactions are carried out, and that price shows up in the market. This goes on all the way through trading hours and even into after trading hours.
To find a company’s total overall value, just take the price of the stock and multiply it by the number of shares. If you compare just the share price of two firms, you won’t learn anything useful.
What Causes Stock Prices to Move?
In a perfectly rational world, stock prices would only move based on supply and demand.
However, the market is made up of human beings, and as may be obvious to anyone paying attention, we do not always behave rationally.
While earnings definitely affect the price of stock in any company, investor sentiment, expectation, and attitudes play a huge role.
For example - did you know it is possible for a stock’s price to move down if a company announces good earnings?
It does happen, and it is mostly because the investors expected the earnings to be even better, and are thus disappointed.
There have been many attempts to fully understand and explain what causes stock prices to move, but no single theory can cover everything.
It is best to take a holistic approach and realize that there are multiple factors at work all at the same time. We have outlined some of them below.
How stock prices are determined isn’t an easy question to answer, and there will always be an element of mystery involved.
That said, if you take on board what has been outlined in this quick guide, you will be as well equipped as most to predict what might happen next with a company’s stock.
Remember, nobody has a crystal ball and nobody can say with any certainty what might happen next with any given stock. The above are merely observances based on what tends to happen given certain conditions.
If you pay attention, you will notice these same patterns yourself and be able to capitalize on tem.