Understanding How Are Prices Of Stocks Determined: Equity markets are known for generating wealth over a long period of time. Therefore, it attracts a lot of interest from people who look to invest their savings and generate returns. A stock market is a place in which investors can trade several financial instruments like bonds, shares, and derivatives.
Stock exchanges are responsible for mediating the buying and selling of stocks. The stock market is further divided into 2 markets: The primary market, and the secondary market. A primary market is known as a market where companies can float shares for the first time to the general public through IPO. Later on, these shares are traded in the secondary market.
This article will cover this and will give a fair idea of what all factors come into the picture for determining stock prices. By the end of this article, you should be able to understand the basic mechanics of the equity market in India and how are prices of stocks determined.
Basic Economics Come into Picture
Share prices are mainly determined by demand and supply forces. Demand means the number of shares that individuals want to purchase, and supply is the number of shares people are willing to sell. The discovery of price happens where forces of demand and supply meet. That level is called equilibrium i.e., both buyer and seller are willing to trade at a particular price point.
When prices rise on a continuous basis, it is called an uptrend, and if the prices continuously drop, it is termed a downtrend. If the demand for the stock of a particular company is higher than its supply, the price will escalate.
The demand and supply of a company get affected by underlying business. If the business is doing well, demand for that particular business improves. This is because investors tend to get excited and they want to own a part of the company. The increase in demand results in higher prices.
Conversely, if the business of the company is expected to incur losses in the near future or investors believe a particular company will not be able to manage risks, the demand for the business falls. Thus, investors start selling their holdings. As a result, a situation is created when supply exceeds the demand. Therefore, a downward trend starts.
factors impacting A Company’s fundamentals
Since the quality of the business helps in determining the demand and supply, some believe that it is important to understand the factors impacting the fundamentals of a company. These factors let you know how are prices of stocks determined.
1. Fundamental factors
The financials of a particular company are knowns as fundamental factors. The financial performance of the business is one of the most important factors which affect share prices in India. Investors tend to overlook companies having weak financials. Therefore, the share prices of these companies fall over time.
Traders and investors looking to generate wealth always invest their hard-earned money in companies with exceptionally strong financials. They believe that these companies have the capability to perform and deliver returns over the long term.
2. Industry performance
More often than not, the stock price of the companies in the same industry moves in tandem. The main reason behind this is the market conditions that generally affect the companies in the same industry in the same way. However, sometimes the stock price of one company can benefit from a piece of bad news from its competitor. At times, any specific news to one company can also have an impact on its share price.
Investors discount the impact of the present economic conditions at the time of predicting the price movement of shares. The state of the country’s economy and global developments are the factors influencing share prices. Apart from domestic investors in the stock markets, there is a huge involvement of foreign institutional investors (FIIs).
When a country’s economy exhibits signs of a slowdown, it discourages investments from foreign investors. If the situation becomes worse, they might decide to sell their holdings and move the capital to stable economies.
Therefore, GDP data, employment data, inflation data, etc. are some of the factors which can impact the share prices. For example, if the retail data shows that there has been a decline in consumer confidence, the shares of retail companies can be impacted heavily.
4. Government policies
Policies of the Government can also impact the movement in the share prices. If the policies announced are perceived as favourable, the share prices of the associated industries and companies can rise. On the other hand, unfavourable policies can impact share prices in a negative way. Subsequently, the investors will sell their holdings which will result in a downtrend. Policies that are related to taxation can have a huge impact on share prices.
5. Political scenario
Investors try to avoid countries where the political scenario is unfavourable or unsupportive. This is because there is a risk of capital erosion. If there is any major shift in the internal political scenario, it can impact the stock prices.
Competitive advantage, the business model of the company, management quality, solid financials, etc. are some of the common factors which affect the movement of the stock prices. Other factors include the company’s news and performance, sentiments of the investors, and economic factors.
Therefore, it is always advisable to understand the basics of the stock market before entering it. Investors should never rely on past performance and should always conduct their own research before making investments.
Hope this blog gave you an understanding of “How Are Prices Of Stocks Determined”. Happy Investing!
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