As investors, we are often confused when it comes to stock prices changing either quickly or rather infrequently. These inconsistencies are often explained by the demand of the stock when the market is open. However, few investors know why stock prices drop or rise so quickly which might also lead to making impulse decisions. That said, if we understood the mechanics of price movements, we will be less compelled to make a move when there is a sudden dip or spike in share prices. In this week’s post, we will be going through the ins-and-outs of price movements and why we should not be overly affected by price volatility.
Volume, Demand and volatility
The propensity of stock price changing is caused by three main factors. The volume of trades often increases the willingness of buyers and sellers’ to buy or let go of their stock at a higher or lower price respectively. That is the reason why stock prices actually change, because the majority of buyers or sellers are more willing to accept the ask or bid price at the moment. A sudden surge in demand to let go or buy stocks is often caused by news items, financial results, or even rumors. As such, depending on the validity of the speculation or news item, investors might be swayed to believe that the price will be falling in the morning but switch back to a more hopeful state of mind in the afternoon. Thereby leading to massive volatility and to a certain extent unpredictability, which is also one of the few leading causes for impulsive investors to enter or exit at the wrong time due to sudden massive price movements.
Last traded price distorts value of stock prices
Some stocks are not regularly traded however, the way the stock exchange works is that the current price of the stock will be the price of the last successful transaction, hence if any stock was traded successful (regardless of volume) right before closing at a ridiculous price, then the price of the stock will be tagged to it even if the price was traded at a way higher or lower price during the day. This misleads many inexperienced investors to believe that there was indeed a sudden surge or dip in share prices however, usually, the change in share price will be rectified the next day as the vast majority of shareholders are still aware of the legitimate price of the stock and will continue ask or bid for it accordingly.
Buying and selling volume does NOT affect stock prices (conceptually)
Many of us have heard or read about buying and selling pressure but what does it really mean? Basically, the short explanation has been explained in the first point of this post however it is important to note that the volume itself is independent of price changes. For example, you might have noticed some stocks with famously high volumes albeit having only small price fluctuations. The reason behind this is because, for every successful buy or sell, an accompanying sell or buy must be carried out for that trade to be carried out. Therefore, it is not how many people who are looking to buy or sell that change the price of shares. Instead, it is about the willingness to ask or bid for an increasingly higher or lower price that leads to price movements.
Closing Thoughts
So how does this information help us as investors? Basically, the “willingness” of investors to buy or sell at a certain price is ever-changing depending on subsequent price movements, news developments and rumours after the trade. Thus, as investors, we must not be overly affected when prices change suddenly or if there is a ridiculous spike or dip especially when it occurred at closing. After all the current price is caused by the most recent trade rather than the actual value of the stock.
