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Friday, July 31, 2009

What Causes Stock Prices To Change

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Stock prices change every day as a result of market forces. By this we mean that share prices change because of supply and demand. If more people want to buy a stock (demand) than sell it (supply), then the price moves up. Conversely, if more people wanted to sell a stock than buy it, there would be greater supply than demand, and the price would fall. Understanding supply and demand is easy.

What is difficult to comprehend is what makes people like a particular stock and dislike another stock. This comes down to figuring out what news is positive for a company and what news is negative. That being said, the principal theory is that the price movement of a stock indicates what investors feel a company is worth. Don't equate a company's value with the stock price. The value of a company is its market capitalization, which is the stock price multiplied by the number of shares outstanding.

The most important factor that affects the value of a company is its earnings. Earnings are the profit a company makes, and in the long run no company can survive without them. It makes sense when you think about it. If a company never makes money, it isn't going to stay in business. Public companies are required to report their earnings four times a year (once each quarter). Market watches with rabid attention at these times, which are referred to as earnings seasons. The reason behind this is that analysts base their future value of a company on their earnings projection. If a company's results surprise (are better than expected), the price jumps up.

If a company's results disappoint (are worse than expected), then the price will fall. The important things to grasp about this subject are the following: 1. At the most fundamental level, supply and demand in the market determines stock price. 2. Price times the number of shares outstanding (market capitalization) is the value of a company. Comparing just the share price of two companies is meaningless. 3. Theoretically, earnings are what affect investors' valuation of a company, but there are other indicators that investors use to predict stock price. Remember, it is investors' sentiments, attitudes and expectations that ultimately affect stock prices. 4. There are many theories that try to explain the way stock prices move the way they do. Unfortunately, there is no one theory that can explain everything.

Conclusion Stock means ownership. As an owner, you have a claim on the assets and earnings of a company as well as voting rights with your shares. Stock is equity, bonds are debt. Bondholders are guaranteed a return on their investment and have a higher claim than shareholders. This is generally why stocks are considered riskier investments and require a higher rate of return. You can lose all of your investment with stocks. The flip-side of this is you can make a lot of money if you invest in the right company. The two main types of stock are common and preferred. It is also possible for a company to create different classes of stock. Stock markets are places where buyers and sellers of stock meet to trade. Stock prices change according to supply and demand. There are many factors influencing prices, the most important of which is earnings. There is no consensus as to why stock prices move the way they do.

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