The stock market is a complex, interrelated system composed of large and small investors making uncoordinated decisions about a huge variety of investments. The market could be construed as an ecosystem organized by an invisible hand. Each market participant acts and plays freely based on their individual ideas and following their own personal interests. "The market" is shorthand for the collective values of individuals and companies.
There are basic economic principles that can help explain up and down market movements, and with experience and data, there are more specific indicators that market experts have identified as being significant.
- "The market" is not a monolithic entity but a complex system of individual, professional, and institutional investors, each making decisions based on their own views and interests.
- The law of supply and demand holds true as in any market.
- Some factors, such as the rate of inflation, have the power to move the market as a whole higher or lower.
- Other factors, such as corporate earnings, may move a single company or an industry sector.
The Basics: Supply and Demand
In a market economy, any price movement can be explained by a temporary difference between what providers are supplying and what consumers are demanding.
This is why economists say that markets tend towards equilibrium, in which supply equals demand. This is how it works with stocks, too. Supply is the number of shares people want to sell, and demand is the number of shares people want to purchase.
If there is a greater number of buyers than sellers (more demand), the buyers bid up the prices of the stocks to entice sellers to sell more. If there are more sellers than buyers, prices go down until they reach a level that entices buyers.
Individually, security instruments like stocks and bonds are dependent on the performance of the issuing entity (business or government) and the likelihood that the entity will be valued more highly in the future (stocks) or be able to repay its debts (bonds).
Widely Accepted Market Indicators
This begs another question: What creates more buyers or more sellers?
Confidence in the stability of future investments plays a significant role in whether markets go up or down. Investors are more likely to purchase stocks if they are convinced their shares will increase in value in the future. If, however, there is a reason to believe that shares will perform poorly, there will be more investors looking to sell than to buy.
Events that affect investor confidence include:
- The publication of economic indicators such as the Consumer Confidence Index
- Wars or other conflicts
- Concerns over inflation or deflation
- Government fiscal and monetary policy
- Technological changes
- Natural disasters pr extreme weather events
- Corporate or government performance data
- Regulation or deregulation
- Changes in the level of trust placed in an industry such as the financial sector
- Changes in the level of trust placed on the legal system
The largest single-day decrease in the history of the Nasdaq Composite Index took place on March 16, 2020. The market "lost" (traded down) 970.28 points, over 12% of its value. This move is attributed to the COVID-19 pandemic, which created a lot of uncertainty about the future. Therefore, the market had many more sellers than buyers.
Interest rates also may play a role in the valuation of any stock or bond. There are several reasons for this, and there is some debate about which is most important. First, interest rates affect how much investors, banks, businesses, and governments are willing to borrow, therefore affecting how much money is spent in the economy. Secondly, rising interest rates make certain "safer" investments (notably U.S. Treasuries) a more attractive alternative to stocks.
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