GOBankingRates

What Makes Stock Prices Go Up or Down? Here Are the Reasons

Sitthiphong / iStock.com

Stock prices go up and down based on supply and demand. When people want to buy a stock versus sell it, the price goes up. If people want to sell a stock versus buying it, the price goes down.

Forecasting whether there will be more buyers or sellers of a certain stock requires additional research, however. Buyers are attracted to stocks for any number of reasons, from low valuation to new product lines to market hype.

Learning how the stock exchange works is the first step in understanding the factors that make a stock go up and down; knowing what makes stocks valuable can help you predict which ones are more likely to rise.

What Makes a Stock Price Go Up?

A stock is simply an ownership share in a physical company. Stock shares allow investors to buy or sell an interest in a company on an exchange through a bidding process. Sellers indicate prices at which they are asking to give up their shares, and buyers similarly post prices at which they’re bidding to buy shares. This is known as the bid-ask spread.

Building Wealth

Supply refers to the number of investors willing to sell their shares. Demand refers to the number of investors willing to buy shares. When more buyers are willing to pay sellers’ asking price than sellers are asking for that price, a stock price will go up to the next level at which sellers are asking. Here’s a simplified example of how supply and demand work in the market:

An Example of Supply and Demand

Buyers

  1. Investor A offers $10 to buy a stock.
  2. Investor B offers $10.10 to buy a stock.
  3. Investor C offers $10.20 to buy a stock.

Sellers

  1. Investor D asks $10.10 to sell the stock.
    • The first published trade occurs at $10.10, when Investor B buys from Investor D.
  2. Investor E asks $10.20 to sell the stock
    • This trade occurs when Investor C enters the market and pays $10.20.

This shows how investor demand can drive up the price of a stock. After the first trade at $10.10, no more sellers are willing to accept such a low price. The next trade occurs at $10.20, as the demand to pay a higher price exceeds the willingness of sellers to accept a lower price.

Building Wealth

What Makes a Stock More Valuable?

When there is high demand — that is, having more buyers than sellers — is what physically drives up a stock price, buyers must be attracted to the stock for that to happen. One of the factors that drive demand is valuation. Companies can be valued in several different ways, but earnings per share, which represents a company’s profitability, and the price-to-earnings ratio, which compares a company’s share price to its earnings per share, are two common factors in the equation.

Profitability and Stock Interest

Earnings per share represent a company’s profitability. It’s also a metric for comparison to other companies in a particular industry. For example, if one company in the same business is twice as profitable as a competitor, it’s more likely to draw investors’ interest.

EPS is calculated by dividing a company’s profit by the number of its outstanding shares. If Company A had $1 million in profits last year and one million shares outstanding, it would have had an EPS of $1. If it has $2 million in profits this year and one million outstanding shares, it’ll have an EPS of $2.

Compare that to Company B, with $10 million in profits last year with 20 million shares outstanding, giving Company B an EPS of just 50 cents even though it had larger profits than Company A. If Company B has $15 million in profits this year with 20 million shares outstanding, its EPS will be 75 cents. Despite having higher profits last year and a larger increase in profits this year, Company A’s valuation is higher because its EPS is higher.

Generally speaking, investors are more interested in companies with rising earnings.

Building Wealth

The P/E ratio is another metric for comparison that investors use to value stocks. The P/E ratio simply consists of a stock price divided by its EPS. If Company A’s stock price is $50 and its EPS is $1, its P/E ratio is 50. If Company B’s stock price is $50 and its EPS is 50 cents, its P/E ratio is 100.

On a simplified basis, a company with a lower P/E than another within the same industry may be more attractive to investors, as it can be considered undervalued.

What Makes a Stock Go Up and Down?

Although factors such as earnings per share and P/E ratio are standard metrics of valuation, many other factors can impact whether a stock goes up or down. Some of these include:

Technical Factors

A whole segment of market participants utilizes market data to determine which stocks should be bought and when. Technical analysis relies on price movements only, rather than other valuation factors, and investors often track them on charts. Patterns in the charts provide insight into how a stock price might move.

Building Wealth

Technical analysis makes three assumptions, according to Fidelity:

Exogenous Events

Sometimes, valuation, technical analysis and other factors don’t matter as much as global events. In times of great fear or panic, such as after 9/11 or when coronavirus became a global pandemic, markets tend to sell off, regardless of valuation or earnings. Similarly, in times of great optimism, stocks tend to trade up, even when considered overvalued by traditional standards. These events are termed exogenous events because they occur outside of the typical models.

Macroeconomic Environment

Any economic factors that can hurt corporate earnings can also depress stock prices. Inflation is one example. Historically speaking, high inflation has tended to drive stock prices lower. This is because inflation causes higher prices, which makes it more expensive to run a business.

Current Market Trends

Sometimes, stocks go up simply because they have been going up. In a strategy known as momentum investing, investors buy shares in rising stocks and sell shares in those that are following. This momentum builds on itself and continues to drive rising share prices higher. Also known as relative strength investing, this strategy follows market trends to select stocks rather than other traditional valuation metrics.

Building Wealth

Investors try to identify trends early to maximize the time they can profit from the run-up — and minimize the time it takes to sell stocks on the decline. This strategy can be rather volatile, as it amounts to timing the market. Tools such as stop loss, which is an order to sell a stock when it drops to a certain price, can help offset some of the risks.

How Do You Know When a Stock Will Go Up?

Despite all the ways to evaluate stocks, the truth is that no one can say with absolute certainty when a stock will go up in value or down. However, in the long run, the trend in the overall stock market is up. Your best bet when looking for stocks that will go up in price is to evaluate factors that tend to drive prices higher, including those described above:

You can also use these factors to help you know when to sell stocks.

The bottom line when it comes to investing is that although certain factors can help predict stock movements, the best approach is to have a diversified portfolio. Rather than putting all your eggs in one basket, owning several different stocks and investing in a variety of asset classes can help smooth out the ups and downs of your portfolio.

Daria Uhlig contributed to the reporting for this article.