How share prices are determined

Don’t understand what pushes share prices to move? Here’s a brief explanation.
How share prices are determined
Reading time: 5 mins

If you’re new to investing, share prices, also referred to as stock prices, can be a bit of a mystery. They go up and down and barely stop fluctuating. But why? What are the factors that decide where share prices land?

 

How are stock prices determined?
Stock prices are dependent on the forces of supply and demand. If you’re not familiar with these, it simply means that prices will rise when there are more buyers (demand) than sellers (supply). And they will fall when there are more sellers than buyers.

If share prices increase for a sustained period of time, we could potentially see the start of a bull market. Similarly, if share prices continue to decrease abruptly, we could well be entering a bear market. Here’s a blog explaining the difference between bear and bull markets.

 

What pushes people to buy and sell?
There isn’t an exact reason that can explain the behaviour of investors. Instead, there are many factors that could influence their decision to buy or sell. For instance, they think a company has the potential to do well in the future and they want to benefit from its expected success, so they buy shares, pushing the price up. This is what happened in the 1990s with Internet-based companies (dotcoms). Investors were convinced these businesses would thrive, so they invested in them, and for a moment the price of their shares skyrocketed. But once the companies showed signs of struggle, investors started to sell their holdings and share prices went down very quickly, provoking a crash.

Another factor that can influence investors’ decision to buy or sell is uncertainty. When economies slow down, or political tensions break out, or a new virus spreads across the globe, a sense of panic can take over the markets, and many investors end up selling their investments to try and limit potential losses. But by panic selling, all investors are doing is pushing share prices down and making their losses real. Times of uncertainty can be stressful and it’s normal to feel concerned, but if you’re investing, it’s important to try and keep your nerve. Once things calm down, markets could go up and if you’re no longer invested, you could be missing out on potential gains. And think about it. If prices are being pushed down by panic selling, this means that investments are getting cheaper. So why not possibly grab the potential bargains? That way, if markets and the value of your investments rise, you could be making a gain.

 

Can we expect prices to always move?
It’s very rare to see share prices stagnate. There’ll usually be a bit of movement, whether it’s up or down. Most of the time, share prices will move steadily. But sometimes, prices will swing quickly and abruptly. This is exactly what happens when markets drop, and we would typically talk about high volatility.

But what causes share prices to move that much? Emotions! Investors are undeniably human, meaning they can be quite emotional. And the thing with emotions is that they can lead you to make irrational decisions. That’s partly why people sell their investments when things get tough in the markets. That’s also why share prices tend to swing a lot during market downturns. And although high volatility can be intimidating, it’s not necessarily bad news for investors. High volatility typically comes with more risk and potentially larger losses compared to periods of low volatility. But it can also provide investors with opportunities. After all, a risk isn’t always synonymous with loss, it can also mean potentially higher gains.

So, during times of high volatility, it could be worth holding onto your investments until the storm passes. People who remain invested longer are more likely to make a positive return, than investors who leave the markets on volatile days. For instance, if you had invested £10,000 in the FTSE 100 at the start of 2000 and remained invested until the end of 2019, you could have ended up with about £21,255. In other words, your money could have grown on average by 5.4% on an annual basis (including reinvested dividends). If you had taken your money out during this time frame, you could have missed some of the best days and your gain may have been much lower. And depending on how long you were out of the market, you could have even made a loss1. A good thing to do when volatility rises is to try and be patient.

 

Reference:

1: Data from Bloomberg

 

Past performance is not a reliable indicator of future results.

 

Please remember the value of your investments can go down as well as up, and you could get back less than invested.

 

Share this article on:

Wealthify Customer Reviews