5 Forces That Drive Stock Prices

In the arena of equity investments, investors and traders set up their trades on fundamental or technical analysis. Many of them want to participate in the market because of hunches about economic and political events and use inside information to play on the specific stock/sector or simply on optimism or based on gut feeling.

Every investor should analyse how did he feel the last time when he placed an order? Were you excited to take a position or afraid of your bet? Did you feel elated or abused by the market forces?

In totality, the movement in the stock price or in any benchmark indices is the sum of all feelings of millions of investors or traders which when complied into the humongous psychological wave, moves the stock prices and indices.

Here, in this piece of work, we try to describe 5 forces that drive the stock price in an open auction market.

1. Crowd psychology and you

Crowd psychology plays a vital role in setting a stock’s price; the gathering of all the buyers and sellers decides the length and direction of a stock price in the auction market. For instance, if a handful of traders betting long on a particular stock based on their assumptions or hope, but if the majority of crowd is betting against it, the underlying's price would ultimately follow the psychology of the crowd and drive into a sea of lost hopes for those who are betting against that of the general crowd. Therefore, despite how good the company is and its past history, it is market forces which ultimately define the goodness of the stock by the setting the extent and direction of an underlying. So, before placing an order it is utmost important for traders or investors to gauge where the needle is moving on the stock; one should not get carried away in the equity market based on his gut feelings or halo effect.

2. Underlying Fundamentals

Time and again, it has been proved that it is underlying's fundamentals which determine the direction of the stock price movement in the long run. If we delve into the multibagger stocks identified in the past like Amazon.com, Netflix, GlaxoSmithKline Plc, and many more, there was one thing which was common in all these companies; and all were having sound fundamental and performed consistently to sustain those strong fundamentals. Whether it is Benjamin Graham, Warren Buffet, Goldman Sachs, Peter Lynch, George Soros and other ace investors, they emphasise more on the underlying's fundamentals. Because the fundamental is the cornerstone behind the success of any stock in the long run. Because one cannot manipulate a stock or abuse the market more than a day’s trading, week’s trading and a month over any particular period. The fundamental of a stock is the one which drives its prices in the long run.

In our sense, a fundamentally strong company commands respect in the industry, attracts the best talent available in the market and more often their stocks trade at a premium price against relatively weaker or fundamentally unsound peers or rivals.

3. Valuation Matters

As the legend investor Warren E Buffet said that, despite how good a company is or their offerings are, one should never overpay for their stocks just because one is affected by some sort of hallow effect and domino effect. Because buying an ounce of gold at a price which it should fundamentally command in future is not an intelligent investment. Rather one should try to identify stocks which are carrying decent fundamentals and their stocks are trading at a discount to their intrinsic valuation. There an investor can realise a huge gain on his investments. Therefore, valuation plays a vital role in stock investing and decides the success of an investor’s trades as well. However, valuing a company is both art and science and backtesting of your valuation model is necessary to zero in on good bets in the market.

4. Liquidity

Liquidity determines how quickly one can get into or move out of a stock. Liquidity risk is very prevalent in the stock market, especially in the case of small caps, where liquidity is usually low. Liquidity means the number of shares available in the market for trading; higher the availability, more liquid the stock is or vice-a-versa. For instance, if you are getting the best deal in the market or price at which you have decided to square off your position or take a position, and if the quantity demanded is higher than the quantity of supply, you may not be able to carry out your transaction in the absence of absolute liquidity. The collection of all the buyers and sellers in an open auction market sets the price of a stock and if there is a substantial mismatch between Bid and Ask quantity demanded, then it would be tough to get a better price for your investments.

5. The Ignored essentials

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1. Volume-based indicators: When volume contracts during a stock rally, it reflects that bulls are less keen to buy, and bears are no longer betting for the cover. The smart bears have left long before and declining volume indicates that fuel for an uptrend in drying up and it is all set a register a reversal. However, when volume falls in a downtrend, it reflects that bears are less keen to go short, while bulls are no longer running to cover their positions, as the smarter bulls have liquidated their position a long time ago.
2. Crossovers: Crossover commands high respect in the field of technical analysis, as they occasionally appear. Mainly, the Golden Crossover and Death Crossovers, as they form over a long-term period and are classic signals to bet for or against the trade. The golden cross appears when a stock's short-term moving averages (50-day SMA) crossover its long-term moving average (200-day SMA), which is typically recognised as strong buying point, as the stock carries a higher potential to move up after it formed a golden cross-like pattern. In the opposite, the death cross appears when a stock's short-term moving average (50-day SMA) crosses below its long-term moving average (200-day). It is typically considered a point where short sellers could get benefited from their short bets.

• Cycles: Long-term price cycles are the outcome of economic cycles- when an economy is flooded with liquidity, stock market tends to move up while shrinking liquidity because of the central bank's policies it pulls down a market. Understanding of economic cycles and industry cycles provide a headroom for more rational bets.