What Makes Share Prices Move?

Why do Share Prices Move?

One aspect of investing in shares that persuades many investors to shy away from them is the seemingly unpredictable manner in which share prices move.

Though shares have performed better over the long term than any other asset, with average long term gains of around 10% to 12%, they are still considered to hold greater inherent risk than other assets. Perhaps the main reason for this is their volatility over short periods: after all, the long term gain may be, say, 10% per year, but if shares are down by 30% in the year an investor needs to realise cash from his investment then that may wipe a large part, perhaps all, of his gain to date.

Facebook Share Price Movement

What produces such good long term growth?

The main driver of long term rising share values is long term increasing earnings. As company profit rises, so does the ability to pay greater dividends to shareholders. Companies who make strong and consistent advances in profits are viewed with confidence by the market and investors. Their shares become more in demand, and their shares rise.

Rather than ask the question what makes share prices move, perhaps the question should be what causes gain and loss in confidence and company profitability?

The answer to this question is any number of factors. Some of these, such as acquisition of poorly managed businesses, will be in the full control of the company. The departure of key staff or management is another factor that could have an adverse effect on both earnings and investor confidence, as will the loss or addition of major contracts. Other factors, mostly outside a company’s direct control, include technological breakthroughs and competitive pressure, and lawsuits brought against it.

Fully outside the company’s control come factors such as changes in interest rates affecting costs of borrowing, sociological changes, tax increases, changes in the law, and the general economy.

All of these factors could have short and long term effects on a company’s finances and earning ability.

Long Term Effects

As society changes and evolves, so do many companies. What once was a a stationary store, selling paper and envelopes, might now be a high class jewellers (Tiffanys). Gap started business as a record store. Then records went out of fashion, and Gap moved into fashion.

Rising interest rates is one of the biggest inhibitors of company advancement. The higher cost of borrowing not only holds back margins, but also makes it difficult to raise and service debt for research and development, a key component of competitiveness and customer appeal.

Shorter Term Effects

Short term effects to share price are numerous. Analysts’ recommendations, rumour, news, short term competitive influences, product recalls… the list is almost endless. Even a hit on the wider market, not directly affecting a company can send its share price in to a short term tailspin.

Sometimes investor sentiment merely shies away from one company. There may be absolutely nothing fundamentally wrong with it, but investors may see better opportunity for growth in the fortunes of another company. Market sentiment is often an unquantifiable and strange beast.

The effect of expectation

Expectations for the future of a company directly influence its share price today. Technical analysts may expect a short term fall in the share price, and traders may sell on the back of those expectations.

It may be that cases of fraud or lawsuits bought by customers will drive the price lower in the short term: partly this is due to the possibility of other lawsuits around the corner, even though they may never appear.

New laws are sometimes passed through parliament unexpectedly. An increase in tax on a company’s products, or the tax status of its offshore activities will harm its profit making ability. A change of government can have a large specific or market wide effect, positive or negative.

Second guessing the market

It’s plain to see that attempting to second guess the market is a futile pastime. There are so many short term influences on price, and many of these come as a surprise, that short term price estimation cannot be conducted with any realistic insight.

On top of this, sizeable blocks of shares are owned by single large institutions. Fund managers may leave and be replaced and investment direction changes. A sudden large seller in the market will drive down share prices, at least in the short term.

Where does this leave the investor?

Short term traders who have the time and inclination to watch markets minute by minute can make large sums of money on short term price changes. But for the majority short term price volatility has to be taken in the context of long term trend. 10% or more as an average annual return should be comforting, and short term falls in price are part of the longer term pattern and perhaps present buying opportunities to maximise returns.. After all, nothing ever goes up in a straight line.

Adam

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Adam is an experienced financial trader who writes about Forex trading, binary options, technical analysis and more.

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