The stock market can be volatile and unpredictable at times, and even seasoned stock market professionals can be caught off guard by sudden shifts. Individual stocks and entire stock exchanges can gain or lose significant value in short periods in addition to showing long-term trends. Knowing how to understand stock market fluctuations can help you to stay ahead of curve in your trading activities.
Keep an eye on the macroeconomic environment. Watch for macroeconomic events that can trigger fluctuations in individual sectors or the market as a whole. Watch for increased consumer savings rates due to increased unemployment, for example, which can strangle demand for things like expensive entertainment products, putting many companies' earnings at risk. A credit boom, on the other hand, is likely to give a boost to industries such as construction and automobiles.
Watch for news stories on individual companies and industries. Expect active traders to react swiftly to news releases. A massive deep-water oil spill, for example, can cause an otherwise strong oil company's stock to take a quick dive, just as the discovery of a new oil deposit can give its stock a boost.
The news can also help you to spot new products and industries that threaten established powerhouses. The rise of the cellphone industry, for example, caused traditional telephone companies' stock to fall so steeply that most players either failed or jumped into the cellular space.
Keep an eye on the legal environment. Watch for new laws and regulations, as well as orders from regulatory agencies, that can make or break companies and products. Pharmaceutical companies, for example, experience fluctuations in stock price when the Food and Drug Administration either approves or denies a new drug for sale.
Understand emotional theory in the stock market. Economics textbooks teach you a wide range of financial decision-making models that apply to stock market investing, all of which rely upon the assumption that all traders act rationally after analyzing all pertinent information. In the real world, however, this is not always the case. Emotional theory asserts that investors do not always act rationally. Traders can unknowingly place more emphasis on recent news than older news, for example, or they can react to quick stock movements without seeking and processing all available information.
Analyze and compare financial statements. Stock investors use companies' financial statements to assess their strength and performance compared to other players in their industry and the company's own previous data. As an example, analyzing a company's financial statements may reveal that their debt-to-earnings ratio has increased significantly over last year's figure, which can help to explain why the company's stock price fell after the annual report was released, even though top-line earnings increased for the year.
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