Determining Stock Prices
Investors calculate long-term stock price targets based on fundamental analysis of the company's strengths and weaknesses
. This process considers the financial and industry strength of the company and examines its competitive advantages.
In the stock market, prices are driven by supply and demand. Supply equals the willing sellers and demand equals the willing buyers.
Where their mutual interests intersect, is the current value. That intersection is a moving target so at one moment there is more supply than demand and at some other moment the balance has shifted to more demand than supply.
This is especially true of heavily-traded shares, but it applies to all. Stock investors can learn from the credit crisis, the damage caused to stock prices from billions in write downs by major financial services, and the declining values in the housing market.
When you read that home prices are tumbling after years of rising in major metropolitan industries, you probably ask why and how.
The answer is that the market has changed, the houses have not. In many major cities, the supply of real estate has been behind the demand.
This created and sustained a sellers' market, which means if there are more purchasers than desirable properties values will raise. Those properties are no less desirable than they were a year ago, however the credit crisis has reduced the number of potential customers.
Tougher lending standards may prevent some from qualifying, while others are just nervous about buying property that may continue to decline in value. The result is there are now more sellers than buyers, which reverses the relationship.
With fewer potential customers in the market, rates will drop as homeowners compete for the sale. In free markets, you must have a willing buyer and a willing seller.
When there are more sellers than buyers, that means that sellers are forced to provide incentives to convert reluctant prospects into customers. This is accomplished primarily by lowering the price of the home.
A prospect is then converted to a customer. In the stock market, the basic principles of supply and demand are the same.
Shares can be attractive for any number of reasons; including great fundamentals, lock on its target market, obtaining new patent, etc. When this happens there tend to be more buyers than sellers.
Sellers may be coaxed into parting with their shares by a higher value. For a share that is out of favor, prospects must be wooed with lower rates to convert them into purchasers.
Supply and demand make sense, but what doesn't always make sense is what causes investors to favor one stock over another. It ultimately comes down to matching willing sellers and willing buyers at a price both agree on for the sale.
If there is a sustained demand -more buyers joining the action-, the price will continue to rise. As the value rises, it will reach a point when owners become nervous and/or want to take a profit.
When the supply of shares for sale approaches and then exceeds the demand, prices begin to fall. Sellers must now make the shares more attractive to customers by lowering the rate.
As the price falls, more holders sell to lock in a profit or cut a loss. This adds to the downward momentum.
At some point, the price will drop far enough that prospective buyers will once again be attracted to the share. When the demand for shares approaches and then exceeds the supply, values begin to rise and the whole cycle starts over again.
This back and forth dynamic between supply and demand may play out over days, hours, minutes and even seconds depending on how actively a stock is traded. The give and take between supply and demand remains the basis for how stock values are set in the market.
This simple illustration demonstrates the underlying forces at work in the stock market. The stock markets are dynamic environments where many factors come in to play in arriving at prices.
by: Ronald Pedactor
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