All of us, whether we know about
stock market or not, know one thing that stock price a stock market fluctuate
all the time. Do we ever wonder why so much fluctuation happens in stock
market? What forces drive the market up and down? There is no concrete equation
or specific reason behind this fluctuation. That said, we do have some causes
identified which drive the stock market.
We can divide the factors behind
stock market fluctuation in 3 categories. They
are fundamental, technical and market sentiment. Let’s discuss about them.
In an efficient stock market,
stock prices are primarily influenced by the fundamentals like Earning Per
Share or EPS and valuation multiple (Price to Earning or P/E). When somebody
purchases a share, he actually purchases the right to claim a future stream of
earning. Simply, a share is the earning right of the profit made by the
Suppose Mr. X bought a share for
Rs 100. The company grew 200% within a year and Mr. X’s share price became Rs
200. That means he would get Rs 100 as profit with the capital remaining
intake. Now, the company might give him Rs 50 as dividend and reinvest the rest
which would ensure the constant flow of earning for Mr. X as well as the growth
of the company.
Now, this EPS is related and dependent to the
valuation multiple. Anticipated future earning is determined by the present
discount in price. A higher growth rate would make a higher multiple, but a
higher discount rate brings a lower multiple. On the other hand, discount rate
is determined by perceived risk and inflation.
Risk is the most active catalyst
here. A stock with higher risk of loss brings a higher discount rate. In this
case valuation multiple remains lower. On the other hand, interest fluctuates
with inflation rate. So, inflation is another player here. Higher inflation
causes higher discount rate. As a result earns price valuation multiple also
becomes lower. This means the earnings in future will be useless for
unfavorable inflationary environment.
There are some technical issues
which indirectly influence the supply and demand of a company’s stock. For
obvious reason, ups and downs in supply and demand mean ups and downs in stock
Inflation is the first technical
player which influence stock price. It’s already mentioned that, higher
inflation brings lower multiple and lower inflation brings the opposite
situation. Deflation on the other hand brings depression in stock market as
deflation reduces the company power to price their stocks.
Substitution of equities is
another thing that influence stock price. When a company compete in the global stage for
investment dollars, is invests assets like corporate equities, foreign
equities, government bonds, commodities, real estate etc. When these assets are
substituted with especially the US equities, stock prices are changed.
Sometimes, stocks are sold or
bought only for their intrinsic value. These transactions are called incidental
transaction. Such transactions influence the stock price to an extent. Even,
market demographics also has role to play in the stock price fluctuation.
Research says that, older investors often tend to meet the retirement demands
in order to pull out of the market. On the other hand, middle aged investors
are the ones who tend to invest more. So, a market with more middle aged
investors has higher demand for equities which consequently increase stock
One last technical factor that has
to be discussed is liquidity. A share with higher liquidity promises higher
return. As a result, price of the share also increases. On the other hand,
shares with lower liquidity has lower price. Now, what does this liquidity
means? Liquidity in the simplest sense means the attraction earning power of a
share. It refers to the amount of attraction a share brings from the investors.
For instance, Wal-Mart stocks have great amount of liquidity as they attract
huge number of investors. Liquidity often needs extensive promotion and brand
The last basic factor we are going
to talk about is the market sentiment, which indicates the psychology of the market
participants. This is the most confusing factor which drives the market from
behind the curtain. Market sentiment is sometimes set by faulty and biased news
and promotion which cause fluctuation in the stock price. Often, a bull market
has a upward trend in stock price while a bear market has downward trend.