Determining Stock Prices

Determining Stock Prices

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Determining Stock Prices

Essentially, stock prices are determined by the supply and demand of the stock in question. To keep the supply and demand in equilibrium, stock prices adjust. This explanation of demand and supply is however on a superficial level, there is a deeper dimension in the determination of stock prices. Different factors often come to play when it comes to the determination of stock prices as expressed by Foucault and Gehrig (2008). Stock prices are modeled to reflect the long-term earning potential of a company. On this, investors get attracted to stocks of those companies that have greater earning potential in the future. In return, the stock prices tend to rise. The opposite happens when the earning potential of companies diminish. 

To settle on purchasing the stocks of a specific company, an investor will often consider the general business climate, the financial condition of the company and the potential prospects of the company are often considered (Lam, Wang, and Wei, 2015). An investor also considers if the stocks of the company is valued above or below normal traditions. The nature of the economic conditions in the national and international economy tend to reflect on the stock prices. For instance, rising interest rates have a significant effect on stock prices. Rising interest rates lower the prices of stocks as they throw a dark shadow to the future of the economy since rising interest rates slow economic activity. Further, rising interest rates tend to lure investors out of the stock market to the interest bearing investments, for instance, treasury bonds, where earning potential are getting high. Falling interest rates reverse this trend and stock prices rise. 

In conclusion, momentum in the market throw the prices of stocks into disarray. Rising prices attract more buyers and the demand of the stocks rise, pushing prices further up. This situation further gets the attention of speculators. The combined pressure makes the market to be bullish. Up to a certain point, the rising prices become unsustainable and prices start to fall and many investors start dumping their stocks and the downward momentum kicks in leading to a bearish market. 

References

Lam, F. Y., Wang, S., & Wei, K. C. (2015). The profitability premium: Macroeconomic risks or expectation errors?

Foucault, T., & Gehrig, T. (2008). Stock price informativeness, cross-listings, and investment decisions. Journal of Financial Economics, 88(1), 146-168.