Want to know a secret…
Why do stock prices REALLY move? Knowing the answer can be the critical understanding you need to interpret a stock chart.
The most surprising thing is few people really understand it
A very common question I get is, “What makes stock prices go up or down?”. Put another way…
Why do stock prices move?
Although it may seem like a difficult question it is quite straightforward.
It is in fact the core question of any of the stock market topics.
Stock prices move due to differences in supply and demand.
The reasons for the differences in supply and demand are where the real details lie.
Many factors change the supply demand equation.
Normal Demand – Normal Supply
This scenario represents an equilibrium between buyers and sellers. This is when a stock is moving sideways on a stock chart neither trending strongly upwards or downwards.
There is no pressure on supply or demand in either direction. On a stock chart we would tend to see an average day of volume and muted price movements. If the market is overall up for the day you might see some upward drift of the stock price, there will also be no significant news that might sway the stocks or demand supply in either direction
Low Demand – Low Supply
This is a day in the stock market where we see disinterested buyer and sellers. Typical volatility is low, there is little movement in the stock price and the volume bars are lower than normal.
High Supply – High Demand
In this scenario we will see significantly higher volume of trades. This means that the buyers are buying heavily and the sellers are equally selling heavily. This means in a stock chart we might see some change in the stock price in either direction but we would definitely see a huge volume bar.
If you view candle sticks you might see what is called a Doji. This means that the increased volumes cause sizable price moves but the opening price and the closing price at the end of the day ended at a very similar level.
This is typically a pattern that suggests a change in trend. From:
- Up to Down
- Down to Up
- or Up or Down to Sideways.
Supply Side Pressure
High Supply – Low Demand
Here the study of supply and demand starts to get very interesting.
Imagine for example, a company announces very poor earnings for the quarter and suggests that the outlook is poor.
Investors who hold the stock suddenly realize that their money could be better invested elsewhere. They start to sell the stock stock at market price.
As the news of the company’s poor earnings get digested the buyers who were once interested in owning the stock suddenly start to back away from purchasing the stock.
This causes a low demand for the stock. When that is combined with the high supply the stock starts to plummet. The stock will fall to a point where the potential buyers start to feel the price is at a level where there is value in it.
High Supply Low Demand 3 Point Example
In this great example of the interplay between Volume and Price we se the following points.
- Point 1 – We see a change in direction of Netflix price and underneath in the volume window we see a surge in volume. This suggests that a lot of people entered the market at this price as the saw value in the stock
- Point 2 – The stock price suges and then we see a BLOW OFF TOP were we observe huge volume and them the price trend move from going up to down.
- Point 3 – We see and explosion of massive buying which causes a GAP upwards.
Chart NETFLIX Ticker NFLX.
Demand Side Pressure
High Demand – Low Supply
Lets take the opposite side of the story. Lets say a company has just announced a record quarter and predicts a rosy outlook for the future.
Those who own the stock are excited and expect to see further appreciation of their investment. Those who have been following the stock see this as the signal to start buying the stock. Those who own the stock are reluctant to sell as they expect more price appreciation, this restricts supply.
Those who want to own the stock are therefor willing to pay more to entice further sellers into the market. This boosts the stock price significantly. In a stock chart we will see a huge volume bar and a jump in the stock price.
Again see Point 3. Massive Buying in the Netflix chart
This gives you a good understanding of what makes a stock price move. But there are many more factors to stock price movements that just earnings and positive outlooks.
Here are some other factors that play an important role:
- Investor Sentiment & Expectation
- M&A Activity – Expected Takeover Target
- Industry Strength – the industry itself is hitting a growth cycle.
- Market Dominance – company has developed a leveragable market dominance
- Competitor Weakness – weak competition and failure of competitors opening up new market share opportunities
- New Product Introductions – innovative product launches
- Analyst Upgrades or Downgrades, these should always be viewed with scepticism
- Political or legislative changes that affects a companies product or business model
Whatever causes the supply and demand equation to change. We should be able to see it in the stock charts and act accordingly.
Do not forget that nearly all stock charts and indicators are based on two things only:
- Stock Price (Open, High, Low, Close)
May the trade be with you.