Why Do Stock Prices Change?

Buyers and sellers affect stock prices.

Stock prices change due to the imbalance between buyers and sellers. The United States and many other countries have moved toward a market economy. Investopedia.com explains that "market economies work on the assumption that market forces, such as supply and demand, are the best determinants of what is right for a nation's well-being. These economies rarely engage in government interventions such as price fixing, license quotas and industry subsidizations."

Significance

The stock markets around the world have grown in size and impact. The vast majority of people who live in industrialized nations seem to own stock directly, own a mutual fund or an ETF, or have exposure to the stock market in their retirement accounts. According to the New York Stock Exchange, the NYSE Euronext exchanges have 8,500 listed issues and a global market capitalization of $16.7 trillion or €12.3 trillion as of Dec. 31, 2008.

Function

The stock market began as a local auction in New York City, where investors would show up to buy or sell shares of a business. This idea of buying and selling shares of a business continued to grow and flourish. Eventually, these auctions grew so much that professional traders entered the scene. These traders would have contacts with outside investors and the traders began to make the auctions even more efficient. Due to the auction structure of the stock market, new information can increase the volatility of the underlying securities.

Benefits

While some investors get concerned about the changes in stock price, the continual changes do offer some major benefits over other types of investments. Investors in the stock market nearly always know the value of their investment. Investors in real estate do not. They have to estimate their property value by examining similar properties that have recently sold. Also for the stock market, anytime an investor needs to liquidate their investment and use the cash for other purposes, the process moves quickly.

Prevention/Solution

Other investment strategies do exist for the investor that has little interest in the volatility that exists with stock investing. One such option would include money market funds. These types of funds do not provide nearly as much opportunity for gain, but do offer extremely stable principle. Another option would include buying a put option that provides downside insurance. While this put option would require the investor to pay an incremental cost, it would ensure the right to sell the underlying shares at a fixed price.

Considerations

The longer an investor holds onto an investment, the time starts to smooth the daily volatility. The 10-day moving average or the 50-day moving average may have better indication of the trends of the stock versus the daily volatility. Many technical analysts use these smoothing effects as tools to predict future trends. Investopedia.com describes technical analysts as securities analysts who look at careful interpretations of past trading patterns. Then these technicians try to discern this balance with the aim of predicting future price movements.

References

• Investopedia: Market Economy
• NYSE: About the Market
• Investopedia: Technical Analyst