Introduction
Stock market prices are affected by business fundamentals, company and world events, human psychology, and much more.
Stock trading is driven by psychology just as much as it is by business fundamentals, believe it or not. Fear and greed are the two of the strongest human emotions that affect the market. For example, it is easy to get caught in the trap of selling a stock prematurely because it dipped temporarily and fear set in. On the other hand, it is also easy to miss out on a respectable gain because greed was telling you to hold out for more, and then the stock drops back down.
One of the main business factors in determining a stock’s price is a company’s earnings, including the current earnings and estimated future earnings. News from the company and other national and world events also plays a large role in the direction of the stock market. Some examples of this are oil prices, inflation, and terrorist attacks.
Every analyst and trader has a different perception of what that stock price should be now and where it might be in the future, and trading decisions are made accordingly.
Bad News or “Good” Bad News?
- Layoffs
This is usually good for the company and its stock price because expenses will be reduced significantly and quickly. This should help increase earnings right away. It is not always a major warning sign; it could just be a reaction to a slower economy. It is one of the quickest ways a company can cut expenses if sales have not been meeting expectations.
- Store Closings
This event often causes the stock price to go up for the same reasons as layoffs. However, this is not always the case. Closing stores actually requires a lot of money, and the positive effects of it do not take place immediately. This could be a sign that the company is truly in trouble at the moment. They probably have lower sales and higher expenses than they want, possibly due to a slowdown in the industry or the overall economy. The good news is that their management is being pro-active about maintaining profitability. Unfortunately, the stock price may go down for the next few months.
- Firing of CEO or Company Official(s)
This may sound very negative at first, but it does show that the company’s board of directors was bold enough to take drastic actions to help the company in the long run. The stock price could go up or down after this announcement, depending on the situation. In some cases this event could be a sign of corruption that reaches beyond these individuals and there could be more negative announcements to come.
- Market Scandals
Traders tend to frown upon corruption in the stock market. Mutual fund scandals that have occurred in the past few years and corporate corruption such as Enron are two such examples. If people cannot trust the stock market, why would they invest their hard-earned money in it? In these situations it is harder for the market to go up because there is a lower demand for stocks.
Analyst Recommendations
Many traders rely on experts’ opinions about companies and future stock prices. Are they always correct? Of course not. Nobody can predict what will happen in the future. They can, however, make educated guesses based on past performances and future prospects for the companies and industries they follow.
Round Numbers
Traders often like nice round numbers for their perceived stock price, such as $10.00 or $35.00. It is common for prices to settle near these round numbers, at least briefly. Also, many traders place automatic buy or sell orders right near these round numbers, causing the stock price to become slightly erratic when it first reaches that target.
Technical Analysis
One of the most popular methods for helping predict a stock’s price, at least in the short term, is called Technical Analysis. This method involves looking for patterns or indicators in stock prices, volumes, moving averages, and many others, over time. Obviously nobody can predict the future but this method can be effective in many cases because human beings are somewhat predictable. For example, when people see a stock start falling dramatically they often panic and sell their positions without investigating what caused the fall. This causes even more people to sell their shares and this often leads to an “overshoot” of the stock price. If you believe the price went too far down you can try to buy it at the bottom and hope that it will come back up to a more reasonable level.
Another common example involves Moving Averages. Many traders like to chart the 50-day and 200-day Moving Averages of their stock prices along with the prices themselves. When they see the current price cross over one of these Moving Averages on the charts it can be an indicator of a change in a long-term trend and it may be time to buy (or sell) the stock.
Click Here to see all Beginner Stock Trading Articles
Expected vs Realized Earnings
The realized and expected earnings of a company have a significant impact on the movement of its stock price. Realized earnings refer to a company’s actual earnings for a given period, while expected earnings are what investors predict the company will earn in the future. When a company’s realized earnings exceed expectations, it is often a positive sign for investors and leads to an increase in the stock price.
On the other hand, when realized earnings fall below expectations, stock prices tend to decrease as investors believe the company’s future prospects may be challenging. Overall, realized and expected earnings play a critical role in determining investors’ perception of a company’s financial performance and can significantly influence the movement of its stock price.
Earnings reports are made available to the public to announce a company’s most recent historical performance. Quarterly reports feature the previous three months, while annual reports provide a snapshot of the most recent year. These reports feature commentary from the company about initiatives and projections moving forward.
The EPS, or earnings per share, is one of the most crucial metrics that can impact stock price movements in the short and long run. During quarterly earnings announcements, analysts create a consensus estimate for a company’s EPS, representing the sum of its net profit divided by the total number of outstanding shares. A company’s actual EPS is then compared to the estimate. If the actual EPS is higher than the estimate, stock prices are likely to rise as investors become more optimistic about the company’s future prospects. In contrast, if the company’s actual EPS falls short of the estimate, stock prices typically fall.
Investors use other metrics and ratios within the earnings report, such as revenue, margins, and P/E ratios, that can further influence stock price movements. Overall, understanding how EPS and other financial metrics can influence stock price movements is essential for investors looking to make sound decisions in the stock market.
Systematic vs Unsystematic Risk
Finally, stock price fluctuations deal with the concept of risk. There are two types of risk, systematic and unsystematic. Systematic risk is an event that can affect the stock market as a whole. Unsystematic risk is specific to the company or industry. Beta is the measure of the volatility a stock has in comparison to the market as a whole. A beta greater than 1 represents a stock that will move higher than the market in periods of growth but decrease more in periods of decline.
Systematic Risk
Systematic risk includes events such as wars, interest rate fluctuations, recession, and geopolitical occurrences. These events tend to affect all stocks regardless of company specific performance and growth prospects. Systematic events are seen as disruptions to the market and generally cause a downward shift in stock prices.
Unsystematic Risk
Unsystematic risk includes company or industry specific events. For example, companies that produced radios were at risk when TVs became popular, or companies that grow and sell vegetables are affected by droughts or hurricanes that destroy their crops. These risks can greatly affect a stock, and often cause sharp declines in price.
