As a beginning investor, you might be considering the best time to buy stocks, and conversely, when would be a good time to sell them. These are excellent questions. Some believe that by drawing charts and looking at past price movements, you can determine the proper times. Others flatly deny the possibility to predict how stocks will change in price. The only thing we know for certain is that stocks are volatile and can change in price extremely rapidly.
When attempting to understand why stock prices rise and fall, it helps to understand the age old law of supply and demand. If an item or service is in short supply, people will pay more for it. On the other hand, when there is abundance the price will fall.
For example, why do scalpers charge so much for Super Bowl tickets? It’s because there aren’t many out there, and everyone is trying to get one. Whether you’re gassing up your car or trying to catch a last minute flight home for the holidays, the law of supply and demand comes into play.
Understanding supply and demand is the easy part. It is much more difficult to comprehend what makes people like one particular stock and dislike another. To attempt to answer that you need to figure out what news is positive for a company and what is negative.
When a company releases news, be it of a new product, line of business, or management change, Wall Street and investors are sure to react to it — for better or worse. If the reaction is positive, the company’s stock price goes up. If it’s bad, the stock price goes down.
Without question, the most important factor to a company’s value — and therefore its stock price — is its earnings. Earnings are the profit a company makes, and in the long run no company can survive without them. Public companies are required to report their earnings four times a year. If a company’s earnings are higher than expected, their stock price increases. But when a company’s results are lower than expected, their stock falls. It’s as simple as that.
Mergers and Acquisitions
Even if you’ve only recently developed an interest in investing and the stock market, you’ve no doubt seen or heard news accounts of buy-outs and mergers. Well, those mergers and acquisitions also affect companies’ stock prices, because mergers and acquisitions permit companies to move into new markets or to maintain dominance in their current market. Market share translates to dollars, which in turn affects stock price and your bottom line. A few years ago when America Online announced that they would buy Time Warner for $183 billion in stock, Time Warner’s stock soared 40 points in a single day.
Ask yourself whether you’d buy stock in a company that was constantly downsizing. If you’re smart the answer to that one is no. Large, publicly traded companies seek to grow and gain market share, and they do that by consistently increasing earnings and revenues. How does a company increase earnings and revenues? Quality labor is a good place to start, and nowhere does that create a greater stir than when it’s at the top. Without quality management, no company can succeed over the long term. So, when a CEO steps down, some might see this as negative, where stock prices fall, while others might accept the restructure as a much-needed progress, inducing stock prices to rise.
Analysts Upgrades and Downgrades
Everyday senior analysts from various firms upgrade or downgrade securities. Sometimes the more well-known analysts do it publicly on television to dramatic effect. News of a strong buy rating with a 12-month price target of $1,000 can potentially send a stock’s price through the roof. Of course the opposite is also true: Strong downgrades can send stock prices plummeting.
In these instances buyers and sellers should beware; such ratings are nothing more than one analyst’s personal opinion. Ultimately the real reason a stock rises or falls in price is the number of buyers and sellers, which relates back to the law of supply and demand.