The stock market is a puzzle for the uninitiated who does not know the ways of the market and how it works. The newbies may enter the stock market without knowing why the stock prices go up and down every day and thus, may lose money. The stock market may seem like a madhouse for a lay person, but there is a method in the madness of the market.
Why do prices of stocks go up and down every day? Well, there are many factors that cause the stock market movement on a daily basis. These factors can be broadly classified into two categories, viz., internal and external. Let us first examine the internal factors that cause the prices of stocks to go up or down every day.
INTERNAL FACTORS THAT DETERMINE STOCK MARKET MOVEMENTS
Internal factors are those that are specific to the company. The fundamentals of the company impact the price of the stock. Let us look at what these fundamentals are and how they impact the stock price movement.
Financial performance: This is the most significant of all the factors. The valuation of the company’s shares on the stock market is determined by the financial performance of the company. If the financial performance is excellent, the equity market will cheer the performance and the company’s stock may see an abrupt spurt in the price. However, if the financial performance is poor or below market expectations, the market will show the ‘thumbs down’ sign and the stock price may take a nosedive.
New product launches and takeovers: If the company launches new products or takes over a rival company, it will more likely increase its market share, which will be a positive development for the company. The company’s share price is likely to be re-rated upwards due to such revenue-accretive initiatives taken by the management.
Management quality: If the company’s management has a high band-width, displays high levels of professionalism, integrity and transparency in its decision-making, it inspires confidence among all the stakeholders and the stock market appreciates the company with high valuation for the stock. However, if there is discord at the top and the management appears to be a divided house, the company’s stock will face the brunt of the investors, who are likely to hammer down the stock price. If top management executives quit the company or if there is a change in the top management, it will reflect either positively or negatively on the stock price, depending upon whether the change is for the better or for worse. Also, if the top management is involved in fraudulent activity or any financial scandal, the stock price is bound to take a beating on the bourses.
Mishap at the company’s factory or office: If there is a fire or explosion at the company’s factory or office leading to loss of lives and/or property, the market will take a serious view of the incident and, depending on the quantum of actual loss and the repercussions arising therefrom, the stock market will discount the stock price commensurately.
EXTERNAL FACTORS THAT DETERMINE STOCK MARKET MOVEMENTS
There are host of external factors that are usually beyond the control of the company, but these factors influence the stock price movement. Let us explore these factors and try to understand how they influence the stock price movement.
Demand-supply mismatch: This is basic economics, where any mismatch between the demand for and supply of the stock will lead to an upward or downward movement of the stock price till equilibrium is established between demand and supply. So, if the demand for the stock exceeds supply, the price will go up till the demand matches supply. On the other hand, if the supply exceeds demand, the price will decline till the supply equals the demand.
Speculative trading: There are stocks where market operators artificially jack up the price or hammer it down and make a killing. These operators indulge in circular trading to pull up or drag down the price of a stock. Such artificial price movement has nothing to do with demand-supply pattern or the fundamentals of the company.
Macroeconomic data: There are several macroeconomic indicators such as country’s GDP growth rate, rising inflation or deflation, fiscal deficit, current account deficit, exchange value of rupee, credit growth rate, industry production and sales data, among others, that indirectly influence the movement of stock market. Any negative movement in these indicators is a dampener for the stock market, while positive movement pushes up investor sentiments and the markets. For example, if the Reserve Bank of India raises repo rate, the commercial banks usually hike their lending rates. In this case, the interest cost of companies having large debt on their balance sheets goes up, which may affect their profitability. Therefore, rising interest rates are a negative for the stock markets.
Government policies and programmes: Any favourable policy decision or industry-friendly initiative taken by the government brings cheer in the stock market, while any move seen as being anti-industry evokes jeers among market participants. In the former case, the stock prices of the concerned companies in the industry will spurt on the back of the favourable policy, while in the latter case, the prices will tumble as a response to the government’s unfavourable stance.
Socio-economic and political situation: The socio-economic and political factors are the key determinants of stock market movement. If there is social harmony and peace and the economic environment is conducive for business, the stock market will react positively. However, if there is civil unrest or communal disturbance and the economic situation is deteriorating, the markets are bound to view such situation with concern and react negatively. That apart, a stable political environment is also crucial for the smooth functioning of the market. If the incumbent government is unstable, the policies and programmes of the government are likely to go into a limbo, which can spell disaster for the markets.
Global factors: The Indian stock market is also vulnerable to global economic situation and political events. The global economic situation and political developments such as the US sanctions against Iran, trade war between the US and China, Italian economic crisis, crude oil price rise in international markets, among others, indirectly but adversely impact the market sentiments.
Relations with neighbouring countries: The Chinese incursions into Indian territory (like the one at Doklam) and the Pakistan-sponsored terrorist attacks in India, such as the attack on Indian parliament or serial bomb blasts in Mumbai, evoke extreme response from the stock market because such events can escalate into full-scale war between India and Pakistan. Such events can trigger a crash in the stock markets.
FII and DII investments: The foreign institutional investors (FIIs) as well as domestic institutional investors (DIIs) many a time dictate the movement of the markets. The massive inflow of funds can cause stock prices to soar, whereas huge sudden outflows can trigger a crash in stock market.
Natural disasters: Natural disasters such as floods, droughts, earthquake, etc. can cause extensive damage to lives, property and crops, which can lead to shortages of agricultural products and commodities. This can impact the stock prices of companies engaged in agri-businesses.
Business cycles: Some of the businesses are cyclical in nature, so when the business cycle is on an upswing, the companies engaged in these businesses put up excellent financial performance, which is then reflected in the higher stock prices. But when the business cycle in on the downswing, the profitability of these companies can take a hit and send their stock prices into a tailspin.
So, one has to take into consideration all the above factors before making an investment in the stock market.