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 is this why? And 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, then we could potentially see the start of a 'bull market'. This is where the prices of investments are rising or expected to rise.
Similarly, if share prices decline abruptly, we could be entering a 'bear market'. A major stock index will need to fall by at least 20% to be considered a 'bear market'.
If you need more context, 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 – people, much like financial markets, can be unpredictable. But there are factors that could influence their decision to buy or sell investments.
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 exactly what happened in the 1990s with Internet-based companies (dotcoms). Investors were convinced that these businesses would thrive, so they invested in them – and for a moment, the price of their shares skyrocketed. However, once the companies showed signs of struggles, investors started to sell their holdings and share prices went down very quickly, provoking a crash.
Another factor that could influence investors’ decision to buy or sell investments is 'uncertainty'. When economies slow down, political tensions break out, or a new virus spreads across the globe, a sense of panic can take over the markets, and many investors will start selling their investments in an attempt to limit potential losses before their values drop.
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 about market downturns, but a loss isn't always a loss.
Let us explain. If things calm down, the markets (and the value of your investments), could go back 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 the markets rise again, you could end up making a profit.
Can we expect prices to always move?
Rather than share prices staying stagnant, there will 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 volatility is high. Put simply, 'volatility' refers to how much and how quickly prices move. And when we experience periods of 'high volatility', it means that they're rapidly going up and down.
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 presents more risk and potentially larger losses compared to periods of low volatility. But it could 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 in the markets, you might want to consider if you want to hold onto your investments and give them time to potentially recover. And data shows that investing for longer periods could increase your likelihood of generating a profit.
For instance, if you'd invested in the FTSE 100 for any 10-year period from 1986 to 2022, you would have had an 88% chance of making a gain.1 And during this time, there were a number of dips in the market due to things like the Global Financial Crisis and the Coronavirus pandemic.
If you had taken your money out during this time frame, you could have missed some of the best days. So, if volatility arises, it could be worth staying calm.
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.
Wealthify does not provide financial advice. Seek financial advice if you are unsure about investing.
