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Thursday, January 17, 2013

What Moves Stock Prices?

People seem to have a quality to invest in markets in hopes of making profits without actually understanding the system of it, and how it works.

You might think, "Duh", when the company is good it goes up the price goes up and when it's not the best the price goes down.

But there is quite a bit to learn if you know that there are so many things you can interpret from a stock just by looking prices, or buyer sentiment, or all in all, charts.

Note: Charts are never enough to base solely a decision on, but they can be invaluable tools to determine trends and momentum.

There are things you might have heard of before; chart patterns. I said I would get into them but there is no reason to explain a chart pattern before I explain how chart patterns have been proven to work with logic.

So let's get straight into it.

How the Stock Prices actually move:

There is something called a market maker. This used to be done with manual workers but now is becoming more of an electronic thing. This is someone (or something) that tries to "balance out the number of buyers and sellers". They don't want too many buyers nor sellers, so they manipulate the price until it is fairly valued. So when there is overwhelming buying pressure, the market maker raises the price until people start to sell. When there are too many sellers, the market maker lowers the price until the buyers start to come in.

*There is also something called a bid and ask. But don't worry about that. That's just how they make money. Also, just remember that the lower the bid and ask spread, the more liquid the asset is. (The easier to sell closer to market price, or what you expect it to sell at)*

But by fairly valued, I mean whatever the general public believes it should be worth. People. Some random  people that don't even research. Some are naive. Very few are insiders. It's not always "fair".

But that is just my opinion, there are 2 types of ways to think about this:

  • Efficient Market Theory: All stocks are fairly priced. The best way to make money is to look at chart patterns and look at trends, and time your entrance and exit to maximize returns.
  • Inefficient Market Theory: Not all stocks are fairly priced. Fundamentals and the company itself will affect the company in the future.
Your choice.

But now to what moves the stock prices, not how it moves.

Things that move the stock market prices:

  • Fear and Greed. In my opinion, the main thing. These are emotions that are programmed into every trader, every investor, every human being. There is no other way to say it, people make stupid or smart decisions based on fear of losing money or greediness, the hopes that their investment will pay off nicely. (Check out the Fear and Greed Index here.) Remember, be greedy when others are fearful and be fearful when others are greedy.
  • Trends. Stocks tend to follow trends. There are many trends out there, such as when great earnings reports come out or when great news come out. Some trends can be greater than others, such as if a largely shorted stock, or stock that has been bet against suddenly comes out with great news, people will rush to cover the shorts resulting in a shot up in stock price.
  • Patterns. This can't be completely trusted as the well-known chart patterns have already been found. But they are good benchmarks when looking at charts.
  • Politics & News. The Fiscal Cliff being solved? The drama that happened before it? The largest 1 day gain in the Dow for a year after the news broke loose? People unleashed hell and bought so many shares that if you looked at the quotes that day everything shed a bright shade of glorious green?
  • Dividends. When companies cut their dividends, the stock price moves down as the dividend support goes down a bit. What I mean is that if the stock price of a dividend paying company suddenly crashes, the dividend will "grow" in value as the company now pays a higher dividend value per share, as the share price has been lowered. When companies add on to their dividends, prices move up and there is little chance that they will actually cut it. Why? They will look bad. No one wants to look bad.
  • Company Itself (Fundamentals). Now this is complicated. The company is only as healthy in it's share price as much as the buyers and sellers in the markets decide it to be. But if the company is healthy, growing well, and not overvalued, (I will teach you how to find this later) it should have had a positive Year to Date (YTD) return, otherwise it must be stuck between a rock and a hard place.
Other than that, nothing else really moves share prices. (Recessions fit into news.) 

You should remember this. You know what? Write this down. Put it in your briefcase because this is the root reason behind all gains and losses in the markets. 

Feel free to comment.

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