Every second the stock market is open, thousands of traders and investors buy and sell stock, causing the price to change and potentially making or losing you money. The reasons for buying and selling, and the factors that affect the stock market, fall within five broad categories. Predict changes in the factors that drive stock prices, and it will help you foresee changes in the direction of the stock market.
How governments respond to economic events, and attempt to steer the economy, affects the stock market. For example, the government may impose a short-selling ban during a market crash in an attempt to stop traders from driving prices too low. Expecting a stock to keep dropping, short sellers first sell and later buy back the stock -- hopefully at a lower price. The Federal Reserve, a government-appointed organization, can also adjust interest rates and money supply. Increasing money supply often has the affect of increasing stock prices as it puts more money in the hands of consumers, making them feel wealthier and more prone to spend. Increasing interest rates, which make it more expensive to borrow money, put downward pressure on the economy and stock prices.
What you think may happen in the future is one of the driving forces behind what you do today in regard to your investments. Speculation is exposing yourself to considerable risk in anticipation of a large gain. During the 1990s, speculation fueled a buying boom in which the public pushed Internet stocks to very high levels. The buying was based on speculation, with very little rationale, company profits or financial data to warrant the high prices paid for stocks.
It is not only you and your fellow citizens that invest in the stock market, but international investors as well. Money coming into, and flowing out of, the country affects the stock market by either increasing or decreasing the pool of money being used to buy stocks. Money leaving the country for other global markets weakens the economy and the currency, and hampers domestic stock performance. Increasing capital flow into the country has the opposite effect. The Balance of Payments and International Investment Position released by the Bureau of Economic Analysis shows trends in foreign investment that highlight money moving into, and out of, U.S. financial markets.
Supply and Demand
Numerous personal reasons drive you to buy and sell, such as a raise at work, financial constraints, looking at price charts or the latest news stories. All these reasons drive supply and demand, pushing and pulling stock prices up and down. If you need to sell, and many others do as well, there will be more supply than demand for shares, pushing stock prices lower. If you and other investors have money to spend, you buy stocks and increase the demand for them. Prices rise as demand rises, until more supply -- or sellers -- enter the market.
Company innovation and fundamentals drive stock prices lower or higher. Big announcements, such as the release of a new product, can cause buyers to flock to the stock and drive up the price. Advances in Internet and computer technology helped fuel the stock market rise of 1980 to 2000. Reporting lower-than-anticipated profits has the opposite effect, driving stock prices lower. What affects one stock also affects others. Disappointing news from one company can cause price drops in other stocks from the same industry. Positive news from one large company increases investor confidence and may pull buyers into other stocks within the same industry.
- Library of Economics and Liberty: Money Supply
- Forbes: In Defense of Short-Sellers: Bans Cost Investors More Than $1B In 2008
- BankRate.com: How Interest Rates are Determined
- Trees Full of Money: Innovation, Speculation and Manipulation Drive the Stock Market
- Bureau of Economic Analysis: U.S. Net International Investment Position at Yearend 2011
- Pro-Fundity.com: Technical Analysis
Cory Mitchell has been a writer since 2007. His articles have been published by "Stock and Commodities" magazine and Forbes Digital. He is a Chartered Market Technician and a member of the Market Technicians Association and the Canadian Society of Technical Analysts. Mitchell holds a Bachelor of Management in finance from the University of Lethbridge.