Why Stock Markets Fall or Rise?
We often hear that the market falls because there are more sellers than buyers while the market rises when there are more buyers than sellers. However, the truth is that this is simply wrong!
ESG Specialist Pankaj Sharma explains that market works on supply and demand in balance principle. It is the price that actually changes. Basically, if the demand and supply get balanced at a lower price, then the market has fallen while the market has risen when the demand and supply balance at a higher price.
Actually, the price of a product/commodity in a traded market provides:
- The value of the underlying asset in rupees.
- A medium for 2 parties to exchange goods for money using a common denominator (INR in India)
- The perspective on the underlying demand for any asset can be calculated based on previous trades and values. Higher price indicates demand.
In terms of economics, the equilibrium price is the price level at which supply and demand of a product or a service match with each other. This translates to increasing supply with increasing price while all other factors remain constant. The change in demand and supply situation also changes the equilibrium price.
Equity markets see company shares getting traded on the same principles. However, the share price also reflects the sentiment surrounding the company’s future potential.
Market Capitalisation= Number of equity shares x prevailing share price represents the value of the company.
Usually, companies don’t raise money by issuing fresh shares, rising share price denotes higher value while value erosion is reflected by falling share price.
Also, because stock markets consist of different people, any development is perceived differently as well. Contrary actions with the trading of respective shares are quite common there.
This means that the same development can lead to someone being a buyer, as he/she is bullish, while it can lead to someone being a seller, as he/she is bearish.
We always see a seller asking for a higher price and a buyer looking for a lower price. But the transaction happens only when they reach a common ground. This means, if buyer 1 is agreeing to seller 1’s price, the share price will be higher but if seller 2 agrees to match the price of buyer 1, then the share price would be lower.
The frequency of transaction changes the share price.
Share prices also change based on new developments or prospects of the company. This means that if there is a positive development regarding the company, then the demand for its shares will increase and the stock prices would rise.
Recently, Amazon Inc. Picked a 40% stake in Reliance Retail and this led to stocks rallying up by 7% in just 2 days.
While this was seen as a positive development by some who bought RIL stock, some saw this as a negative development and sold their shares.
But when Facebook announced to purchase 10% stake on April 22, 2020, the stock rallied 14% in 2 days.
The difference in perspective can lead to one segment of people for a certain time period. This can lead to the movement of the share price based on the actions of those people. Here, people who saw the Amazon deal as positive was more than those who didn’t and this led to a stock price spike.
Thus, upper or lower circuit limits are hit by a stock or index when it reflects a uniform positive or negative bias.
In the above example, most RIL investors were positive and they outnumbered those who thought the opposite. Thus, the share price continued to rise.
Fiscal policy, monetary policy, change in rules and regulations of the business environment, the expected growth potential of the sector etc. also affects the share prices.