One of the major characteristics of the
stock market is the constant fluctuation of the stock prices. Based on the
change in the price of the stocks, huge amounts of profits or losses are made.
It is because of this reason, those people who are actively involved in the
stock market investments tend to monitor the market condition as frequently as
possible. The successful and the experienced investors often try and predict
the market, and the future price of a stock or a group of stocks. This type of
calculated predictions set them apart from the rest of the herd. Thus, if you
want to know how to trade
stocks successfully, then it is essential that you know how to read the
market factors to predict the future stock prices.
However, it is essential to understand that
such predictions are not merely guesses, rather it is a result of a lot of
calculations, based on certain permutations and combinations. Making the
correct decision at the correct moments is a skill which is highly valued in
the stock market. Good understanding of the market, the economic and political
situation can help one to make the right call at the right time. One of the key
aspects of correctly predicting the stock price is understanding the various
factors that determine the price of a particular stock or a group of stocks.
For the beginner investors as well as the
not so highly experienced investors it is very important to know and understand
these factors carefully before making an investment related decision. It only
after careful research and analysis of these factors should a person purchase
or sell their shares. Let us check out the most important factors that
determine the price of a share.
Factors of Stock Prices
The factors that drive the price of stocks
can be broadly categorized into three groups – the fundamental factors, the
technical factors, and the market sentiment. Let us delve deeper into each of
i. Fundamental Factors: Stock prices, in an efficient market, should ideally be determined
by the fundamentals. The fundamentals can conceptually be a combination of two
things – An earning base and a valuation multiple. While a good example of an
earning base can be earning per share, aa valuation multiple can be something
like a P/E ratio or the price to earnings ratio.
Simply explained, the owner of the stock
has a certain claim on his or her earnings, and the earnings per share can be
described as the return on investment for the owner. When an investor purchases
a share, it effectively means that he or she is purchasing a proportional share
of the future earnings of the company. As the future earning of the company can
be higher than what it is at the time of purchase, or it can be lower than that
in the future; thus the price of the share fluctuates depending on how well the
company is doing. Overall, when an investor pays the price of a share, he or
she is actually paying for the expected future stream of earning.
A portion of the earning is retained by the
company for reinvestment, whereas the remainder may be distributed among the
shareholders as dividends.
ii. Technical Factors: These are the factors that can be explained as a mixture of
several external factors that change the demand and supply of a particular
company’s stock. Some of these factors may or not have a direct impact on the
One of the common technical factors that we
hear about on a day-to-day basis is ‘inflation.’ As per the analysis of the
historical data, there has consistently been an inverse relationship between
low inflation to valuations. At the other end of the spectrum is deflation,
which is widely regarded to have a bad effect on the stocks as it signals a
loss in pricing power of the stock-owning companies.
Other important technical factors involve
the economic strength of the overall market and competing companies and
substitutes. Many experts have argued that the price of a particular stock does
not always depend on the performance of the company itself. Rather, it is a
combination of the performance of the entire market and its peers which
determines the performance of stocks. Although, it is yet to be established if
this argument is absolutely correct or not, what is beyond argument is the fact
that to an extent the performance of the market as a whole does have an impact
on individual stocks. Similarly, when different companies are competing for the
investment amount with different asset classes at an international stage, its
impact can be felt on the stock prices.
When discussing technical factors apart
from those mentioned above, there are also other crucial aspects which drive
the price of stocks. Factors like demographics, trends, and liquidity and
incidental transactions, all play a role in determining the price. Thus it is
important to consider all these factors when making an important decision in
iii. Market Sentiments: Out of all the factors, market sentiment can be one of the most
difficult to predict and one of the most frustrating one too. This is because
market sentiment is almost always subjective. There are times when investors
believe that they have made an excellent judgement about the performance of a
stock, and in the future, the projection proved to be right. However, in the
meanwhile the stock may have been kept artificially high or low, owing to
investors reacting strongly to a single piece of news. Frustratingly, it can at
times take a long time for the rest of the investors to realise that and the stock
prices to come back to normal.
Such has been the complexity of this factor
that it is has given birth to a new study called behavioural finance. While
there are some in the market who claim to understand already and benefit from
the studies released, but for most, it still remains an unknown quantity. At
this point, this factor largely remains a mystery for most of the investors,
which includes some of the experts too. It is expected that with more in-depth
studies, at least a part of the mystery will be solved, that can help investors
get better returns.
These factors are important from an overall
point of view. Some of the factors mentioned here may benefit those individuals
who make long-term investments, whereas others who are dedicated to making short-term
profits. Depending on the goal and the resources of the investors, the factors are to be
researched and analysed. So it is best to first come up with a suitable plan
and then conduct the research and study according to that.