What makes the Markets move?
(This is the 2nd lesson on a series of preview chapters for a course that is due to be released soon. Please read the disclaimer before proceeding. If you found this lesson useful, don’t hesitate to share it and please follow us on all our social media for more updates!)
(Thing to note: What I cover in this topic is not really technical analysis, as some people will point out. But I think it is good for every investor to have some basic knowledge on how markets move. Regardless of whether you use technical analysis or not.)
Outline of today’s lesson, we will be covering:
- Supply & demand with apples!
- Applying it to the markets
- The main factors affecting S&D (positive, negative & unexpected)
- Note on the market
- Why learn how the markets move?
- To sum up this lesson
Supply & Demand with Apples!
Supply and demand is basically the simplest way markets move. When demand is larger than supply, prices go up. When supply is larger than demand, prices go down.
Think of a scenario when everyone wants apples. A research article said that you will live 10 years longer if you eat apples. Now you are selling apples and you have 10 apples. But suddenly there are 100 people who want to buy your apples. 100>10, so you can sell each apple for a very high price and the price of apples goes up.
Now imagine the research article says not to eat apples as it is found to be harmful. Suddenly nobody wants your apples! You have 10 apples but nobody wants them. So you keep cutting the price of each apple hoping someone will buy them, hoping that the cheaper prices of the apples will attract people to buy them.
This is basically what supply and demand is.
Applying it to the markets
When there are more buyers than sellers, the price of a stock will go up. This is also called a bull market as the participants are all optimistic and bullish about the market.
When the sellers outnumber the buyers, prices go down. This is called a bear market as the participants are all pessimistic about the market.
The main factors affecting S&D are
- Outlook of the company
- Outlook of the economy
A positive outlook will bring investors and stock prices will rise as the company or economy is growing.
A negative outlook will lose investors and stock prices will fall as the company or economy is shrinking.
Take note that the price of a stock will make a huge jump on UNEXPECTED news. This news can be bullish (positive) or bearish (negative). Let’s look at some examples illustrating positive, negative outlooks and how unexpected news can affect a company.
Positive outlook about a company
In general, people purchase a stock when they feel that the stock will rise in the future. This could be due to a variety of reasons such as when a company just launched a new product which is selling very well ( Apple and their IPhone). This is a case of demand being larger than supply, so the price of the company goes up.
Positive unexpected news
You will find that stock prices rise very quickly on UNEXPECTED positive news in the market as well. When a product is doing better than expected (Pokémon Go), the chart of the stock will quickly show it.
Negative outlook for the company
When a company outlook is bleak, growth is slow or it is getting overtaken by its competitors. The stock price of that company will fall over time.
A good example of such a company is Twitter. They have fierce competition from Facebook, Instagram and Snapchat on the social media platforms. Their growth has been slow and they have not been able to capture much of the social media market share so their earnings are flat. This coupled with a lack of new and innovative features on Twitter leads to a bleak outlook for the company.
Negative unexpected news
People tend to sell a stock when they feel that the company has been affected by bad news. For example, if a company is currently facing the possibility of a lawsuit or caught in a scandal (Wells Fargo), the share price will fall. The drop in price is also immediate and sharp on UNEXPECTED negative news.
Note on the market
- Most of the economies in the world are linked by trade and other factors so you will note that negative news in other countries also has the ability to influence markets. One good example is the China stock market crash of 2015.
- Sometimes the market would “priced in” certain moves. This means the market would react to a possible event as if it were true. For example, if we know that the government has indicated that it would spend a lot on infrastructure. The stock price of most infrastructure companies will rise.
Why learn how the markets move?
I think it’s good to understand the basic reason why the price of a stock moves and how the positive or negative outlook of a stock can affect its supply and demand.
Quick sharing from me
Here is something I personally use to gauge roughly how the market participants are feeling. You can go to CNN Money and they have an indicator to show how the market participants are feeling. Just go to their Markets tab and click on Fear & Greed.
To sum up this lesson
- Supply and demand is the basic factor driving the market
- It is influenced by news regarding the company outlook and economic outlook
- A positive outlook will bring investors and prices will rise
- A negative outlook will lose investors and prices will fall
- Unexpected news usually causes a big jump in price
- Sometimes the market would “priced in” certain news
In Technical Analysis we believe that the all the information we need to analyze a stock, is present in the chart. The reactions from any local or global events will be shown in the charts as market participants would have reacted the moment they saw the news. For TA, we will also cover momentum indicators and oscillators to gauge “S&D” of a stock. Stay tuned!