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.
Determinant 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 the categories.
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 fundamental factors.
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 the market.
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.