Change is the only constant, especially when it comes to share prices. As an investor, it is important to understand the reason behind the changes in share prices. It will help you not only to take well-informed and correct investing decisions, but also save you from a lot of unnecessary panic or heart-burn.
What causes the share prices to go up or down?
Stock markets are known for their volatility and frequent fluctuations in share prices. So, who are the top 3 culprits behind the stock market volatility?
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1) May the force be with you!
The primary reason for stock market turbulence is market forces. The duet performance of demand and supply.
Stock prices change (move north or south) whenever the demand and supply equilibrium is disturbed. When demand increases (people want to invest in a specific stock) more than the supply, it causes the share price to go up. Because, people are willing to pay a premium price for the stock.
Conversely, when there is an excess supply (i.e. demand is lesser than supply), the stock prices go down. Think of it as a clearance sale for unwanted products!
Let us look at how demand and supply get impacted by company related matters.
Changes in the company’s attributes impact its stock prices. Better sales revenue, reduced cost of production or operation, debt repayment, etc. lead to higher future cash flows for the company. Investors see such companies as lucrative investment prospects.
This leads to an increase in demand and resultantly stock prices move up. On the other hand, negative factors such as change or instability in top management, product failures, increase in the manufacturing or operational costs, sharp dip in the revenue, etc. erode investor’s trust in the company. This leads to a slump in demand and stock prices come crashing down.
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2) Troubles in paradise
Our country’s economic condition plays an important role in share price volatility. For instance, factors such as change in interest rates, inflation (or deflation), political turmoil, natural calamities or pandemics (the bingo word for 2020!), financial growth (or de-growth), major changes in macroeconomic policies, currency valuation, etc. have an impact on the stock market movements.
Let us look at some examples:
Inflation eats up your purchasing power and also your investing power. Let us see how. It leads to a swell in the pricing of offerings (goods and services). As a result, people curtail their buying and spending habits. This in turn leads to a fall in company’s product and revenue and hence brings down their stock prices.
RBI makes changes to Repo rates basis the overall economic conditions. If RBI increases the repo rate, borrowing from it becomes costlier for financial institutions.
As a result, they increase their lending rates which makes loans etc. expensive for businesses. This leads to a temporary halt or sluggishness in their growth activities and investors start to sell-off their stocks in anticipation of the company’s de-growth.
Massive selling leads to stock price crash. On the other hand, if RBI decreases their lending rates, it leads to a situation of credit expansion. Perceived as a sign of growth, investors flock to get a chunk of the growth and drive up the stock prices.
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3) Cons of globalization
Globalization has been a boon for all of us. But as they say to enjoy the rainbow you need to put up with a bit of rain. Global economic conditions have an impact on our stock markets as well. Indian market has witnessed a large inflow of foreign funds and investment.
If there is an economic unrest in the foreign countries or change in their country’s foreign investment policies, we may see a sudden withdrawal of such funds from us.
Similarly, if foreign stock markets enter a bear phase, investors might anticipate a cascading or ripple effect in India’s stock markets as well.
Market sentiments (sometimes real and sometimes unfounded) carry the potential to cause massive volatility. All such factors will lead to a crash in the share prices.
Stock markets are volatile. Period. But that volatility is overwhelming only when you do not know how to interpret the cause of the turbulence. If you invest in a disciplined manner, you can capitalize on the volatility and optimize your returns.
All you need is solid understanding of the market workings, good stock selection and a robust (yet flexible) investment strategy. As a wise person once said, for the investor who knows what he (or she) is doing, volatility creates endless opportunities.
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