How do traders and investment firms predict which stocks will pay off big? How do they know when to buy and sell?
Unfortunately, there’s no simple way to predict the behavior of the stock market. A number of factors cause rises and falls in share prices through gradual changes or sharp spikes.
The best way to understand how the stock market fluctuates is to study trends of individual stocks and broad market behaviors.
Table of Contents
- 1 How to Understand the Stock Market’s Behavior
- 2 Understanding Stocks: Factors That Influence Individual Stocks
- 3 Factors That Influence The Whole Market
- 3.1 Factor #1: Inflation
- 3.2 Factor #2: Interest Rates
- 3.3 Factor #3: Oil Prices
- 3.4 Factor #4: International & Domestic Stability
- 3.5 What Are the Effects of These Factors Combined?
- 4 Understanding the Stock Market Trends: Comparison Between Bull Markets vs. Bear Markets
- 5 Key Tips For Different Stock Market Scenarios
- 6 Trading Challenge
- 7 The Bottom Line
How to Understand the Stock Market’s Behavior
Before you can understand the behavior of stocks, it’s important to understand the market. What is the stock market, exactly? It’s an equity market that provides a place for businesses to gain investors and to ideally create growth.
Since it’s so tied to business and industry, there are a number of different things that can affect the market.
Importance of Learning About Stock Movements Before Investing
Say that you have a friend who wants to place a wager on a game of Monopoly. Trouble is, you’ve never played Monopoly in your life.
You’d probably say no to betting on the game because you’ve never played before and you don’t know the rules. Betting money on it would be stupid until you learned how the game worked!
Yet new traders do this very thing on a daily basis. It’s not uncommon for a new, uneducated trader to enter the market like it’s a game, foolishly betting their money without knowing what they’re doing. And they tend to lose money fast. It sucks!
Before you begin investing your hard-earned cash, learn about what makes stocks move. This will make your trades tactical and well thought out, rather than like playing a slot machine or betting on a game you don’t know how to play.
Understanding Stocks: Factors That Influence Individual Stocks
Some factors can have a big effect on individual stocks. In the large scheme of things, these factors may not shake the market at large but may have a deep impact on a particular sector or a particular company.
Here are some of those factors:
Factor #1: Corporate Actions
Consider the company offering the stock in question. What’s their story? What’s going on in their company right now? Changes in the corporate structure, business model, or operations can have a big effect on individual stocks:
Public Opinion vs. Stock Price
If the public opinion in a company is generally high, the stock price tends to go higher. This could be due to good news, a great new product, a big new partnership, or other factors.
On the flip side, if a company goes down in public opinion, the stock price tends to go down, too. This could be because the company is involved in a scandal, the industry is experiencing a downturn or becoming obsolete, a contract key to their business was not renewed, and so on.
To offer an example, say Company A’s CEO steps down. If he or she was doing a great job, the public opinion could go down, meaning that the stock price could suffer.
On the other hand, if the CEO was not great and a big new name is stepping in, it could increase public opinion and increase demand for the stock.
Either way, everyone will be looking at what happens next!
Traders’ Emotions Vs. Stock Price
I’ve written before about trading psychology and how it can affect your actions as a trader. Company developments can also have a deep impact on traders’ emotions, which can affect the stock price.
Corporate happenings such as reorganizing, mergers, and other major structural changes can impact the demand for a stock, which can drive its price up or down depending on whether the reaction is positive or negative.
If a company’s change inspires hope on the part of investors, it can drive up the price of the stock, even before anything happens.
If a company is making a change that inspires fear or seems unknown, it can make the stock price go down, because no investor likes to add uncertainty to an already inherently risky market.
Factor #2: Earnings
A company’s earnings can also have an effect on stock price. Usually, the direct effects are limited to a particular company or sector, though, versus the market at large.
Influence of a Quarterly Earnings Report
In particular, you want to compare the company’s earnings to its prior earnings. So, for instance, you might do a side-by-side comparison of this quarter versus last quarter.
If the profits are higher this quarter than last quarter, this is seen as an indication that the company is doing well. Even if it’s small and potentially short-term growth, it can drive the price upward as more investors want a piece of the profits.
The opposite is true, too. A decrease in sales this quarter versus last quarter can look to be a sign of trouble in the company. Investors can lose confidence in the company and its stock, driving down demand, which drives down price.
Factors That Influence The Whole Market
While some things will only affect individual stocks, there are other factors that can cause much bigger ripples in the entire market.
These are some of the more global factors that can contribute to stock behavior across the board:
Factor #1: Inflation
Inflation is defined as “a continuing rise in the general price level usually attributed to an increase in the volume of money and credit relative to available goods and services”.
To a certain degree, inflation is natural. But sometimes, the volume of money and the market aren’t totally aligned.
In this case, an increase in inflation can have a negative effect on stock prices. Higher inflation can result in a decrease in a company’s stock price.
Lower inflation can have the opposite effect, making stock prices go up.
Factor #2: Interest Rates
Are interest rates on the rise? This could play into stock movement.
An increase in interest rates will lead to a decrease in the stock price because higher interest rates are generally viewed in a negative light and will take up more cash that could otherwise be used for investments.
Lower interest rates, on the other hand, can be a good thing — they can lead to overall increases in stock prices.
Factor #3: Oil Prices
Oil prices are one of the markers that you can look to if you want to determine the tone of the market. Historically, the stock market has reacted negatively to higher oil prices. Inversely, if oil prices go down, the stock market tends to react favorably.
Many industries rely on oil, so it can have bigger effects than just the price of oil itself: it can affect companies in a big way. This means that by looking at if oil prices are trending up or down, you can get a quick pulse on the market.
Factor #4: International & Domestic Stability
Instability in the nation can be a factor in market movement. War, crime, fraud, domestic or political unrest, terrorist attacks, or scandals can affect the market in a negative way.
When things are domestically stable, it can have the opposite effect on the market.
What Are the Effects of These Factors Combined?
What happens when the above factors are combined? In a nutshell, the entire stock market experiences a downward shift. Here’s how it goes down:
Decrease of Consumer Spending Capacity
First, what happens is that with stock prices going down, there’s a reduced spending capacity.
Decrease of Business Profits
Lower stock prices plus reduced spending capacity leads to a decrease in business profits.
Decrease of Investor Confidence
Once business profits go down, investor confidence takes a nosedive, and all of a sudden, company stocks are no longer as desirable.
Increase of Stock Selling
When the value of the stocks goes down, investors want to unload. This means a big supply is unleashed on the market.
Decrease of Stock Demand
When there’s an increase in stock shares, there’s less of a supply-and-demand balance. If there are too many shares, they’re no longer as valuable.
Decrease of Stock Price
Ultimately, the stock price goes down because there’s a lot of stock, little demand, and the market is stagnant.
Understanding the Stock Market Trends: Comparison Between Bull Markets vs. Bear Markets
The market type can give you clues about stock market trends. Here are some predictable trends that take place in bull markets and bear markets, respectively:
1. Market Type
A bull market is a more aggressive, optimistic, and forward market. The bear market is a more sluggish, cynical, pessimistic and downward market.
In a bull market, the market is optimistic and forward-moving, which means prices will go up. In a bear market, the pessimism and lack of investor confidence can lead to declining stock prices.
The shifts can be subtle, though, and sometimes it’s not easy to discern which type of market we’re in.
When we’re in a bull market, the economy is generally overall very strong. It’s like a rising tide that lifts all boats, and stock prices go up.
On the flip side, during a bear market, the economy tends to be weak. This can lower stock prices.
4. Consumer Spending Capacity
Characterized by a stronger economy and more employment, a bull market is prime time for consumer spending capacity, which is usually very high.
Not so during a bear market, where consumer spending capacity is far lower.
5. Business Profits
Business profits tend to increase during a bull market, as opposed to a bear market, when they typically go down.
6. Company Stocks Valuation
Be sure to look at the company stock valuation. In a bull market, stocks are highly valued. In a bear market, they are devalued.
7. Stock Supply
In a bull market, there’s usually a low supply of stock. In a bear market, there’s typically a high supply.
8. Stock Demand
Given the stock supply goes down in a bull market, more demand is created. In a bear market, the higher amount of stock available leads to less demand.
9. Investor Sentiments
In a bull market, the investor sentiments could usually be described as positive and confident. In a bear market, it’s typically underconfident.
10. Do Investors Take Risks?
In a bull market, sure investors take risks; they’re feeling confident and the economy is strong. It’s the total opposite in a bear market — seemingly nobody wants to risk anything.
11. Buy and Sell Trends
That’s easy: In a bull market, investors tend to buy buy buy; in a bear market, it’s sell, sell, sell.
12. Stock Prices
You’ve probably already guessed this, but in a bull market, stock prices increase. In a bear market, they decrease.
Key Tips For Different Stock Market Scenarios
So what’s a trader to do in different market conditions? Here are some tips for making the most of your trading strategy no matter what the current market looks like:
In a Bull Market
Are we in a bull market? If so, consider these principles:
Recognize the Trend Early
If you can get ahead of the masses, you can maximize your profits. This means that you have to be able to identify the trends that are shaping the market before anyone else.
Look for Smart Stocks
Be intelligent in your stock choices. For instance, right now cannabis stocks are the hot sector, so it’s smart to look there. Other stocks may prove to be good seasonal investments.
Be intelligent and stay with the trend. Gain that edge and you’ll be more likely to make better trades.
Hold On For the Ride
By looking at the stock’s patterns that may tell you how long it may trend upward and plan your exit strategy accordingly. But while a stock is hot, it’s the time to ride.
In a Bear Market
Are we in a bear market? If so, consider these principles:
It’s time to short sell when we’re in a bear market, where it’s like hibernation.
When stocks are going down in value, as they tend to during bear markets, it’s the right time to short sell.
Short selling is the opposite of the typical “buy low, sell high” approach to investing. In this case, you’re actually hoping to find stocks that are going down in value.
First, you borrow these shares from a broker, and then you sell them in hopes that they will continue to lose value before you buy them back.
So you’ll briefly take a negative position before rebuying them, hoping to profit from the difference in price. It’s recognizable as a buying/selling transaction but conducted in an unusual way.
U.S. Treasury Bonds
U.S. Treasury bonds can be a great place to look during a bear market. This is because good interest rates tend to rise during bear markets, providing an attractive opportunity during times of economic uncertainty.
Utility stocks such as energy and water are considered defensive, as their value stays pretty constant regardless of the market. This provides a way for investors to keep money in the stock market with limited risk.
Master Your Analysis Skills
Regardless of what type of market we’re in and what stocks are doing right now, you need to work on mastering your analysis skills to make the most of any market.
Stock analysis is exactly what it sounds like: the process of analyzing stocks. As a trader, you will use many different methods of analysis to determine whether or not a stock is going to work with your overall strategy.
While there’s not one cut and dry approach to stock analysis, there are two key types of stock analysis: technical analysis and fundamental analysis. Most of the research you perform will fall under one of these two categories.
So what’s the difference? Let’s discuss:
With technical analysis, you’re looking at the stock’s documented number action. You’ll rely on charts, numbers, and historical data to review a stock’s performance over time. By looking to a stock’s past, you can begin to identify patterns. If it seems as if the stock follows a reliable pattern, you may be able to predict how the stock may perform in the future.
These are some of the things to look at when you perform technical analysis:
- Price changes over time. How sharply, and how much has the stock’s price changed over time?
- Trends in price. Has this stock traditionally been a gainer, or a loser, at particular times? For instance, is it frequently peaking during a certain season or time of year?
- Patterns. Both the price action and the price trends can help you start to look for patterns. When you look at a stock’s chart, sometimes you can actually see physical patterns in the action of a stock, which can help you try to figure out if they’re predictable.
Stocks and the market are all about numbers. But the people who buy them are human. That’s why it’s important to also consider who is selling the stock.
Public opinion can have a huge effect on the price of a stock, so it’s a good idea to do some research on aspects of the company in question that could affect analysts and buyers. This is called fundamental research.
Looking at the company in question can help you identify catalysts that could play into stock price movement.
Consider these things when going through your fundamental analysis:
- Earnings per share. The earnings per share (also called the EPS) is a calculation where you divide the company’s profits by the number of outstanding common shares. This is a metric that many traders consider vital.
- Earnings. Look at the company’s earnings reports. Quarterly earnings reports are required by the SEC, and this is where you’ll discover the truth about the company’s bottom line. You can see if they are exceeding sales goals or not, what their profits and losses are, and read about what the company’s plans are for the future.
- Be thorough. When it comes to fundamental research, separating the wheat from the chaff can be tough. What news is self-serving, and what is the truth? Consult a variety of sources and be sure to look extra close at the small print in that earnings report.
When I started out as a trader, I wish I’d had someone to help me figure out what makes stocks move. As it was, I had to figure it out the hard way, because there were not any great resources out there.
I want to make trading more accessible to others by becoming that resource for my students.
I created my Trading Challenge so that my students don’t have to go through the learning curve of the stock market the hard way.
There’s so much confusion and so many mixed messages out there it’s hard to know what’s what, and many traders get frustrated and quit before they realize their full potential.
I want to help others learn my techniques to potentially take advantage of them, too. As a teacher/mentor, I am actively trading with a small account alongside you so that my teachings can be super specific and tailored to the market as it is right now.
The Bottom Line
There are a variety of factors that can affect stock prices. These include but are not limited to inflation, interest rates, energy prices, oil prices and international issues like war, crime, fraud, and political unrest.
Spikes in price are extremely difficult to predict but based on history, the stock market always rises over time and investors can make estimations of how the market will react to different influences and events.
Recognizing a trend, hopefully before the curve, in an individual stock or the broader market will help you determine the best times to buy and sell.
However, over time, research shows that investing in strong companies with growth potential pays off more than rumors and guesswork!
What’s your understanding of stock movement? Is it as big a deal as I think it is? Leave a comment below.