Lesson 5: What Drives Stock Prices – Napkin Finance

Lesson 5: What Drives Stock Prices

In the stock market, buyers and sellers negotiate prices for shares of stock. When a buyer’s “bid”—what they are willing to pay for a stock—matches the seller’s asking price, they complete a sale. This is also called a “trade” because the buyer and seller exchange money for shares.

Stock prices

Unlike most auctions, in which prices start low but then rise until a sale is made, buyers bid prices up or down as they negotiate trades with sellers. Supply and demand are the primary drivers of stock prices. If there are more shares of a stock available than investors want to buy, that stock’s price drops. If a lot of investors want to buy a certain stock, that stock’s share price goes up.

The demand for a stock depends on a few key things:

  • A company’s earnings, or profits.
    • Companies with bigger profits are more valuable, leading to greater demand for their stock. This drives share prices up. Companies that are struggling financially usually see their share prices fall.
  • How investors think a company will perform in the future.
    • In the early 2000s, for example, Amazon had a period of lower-than-expected profits, but investors kept buying the company’s stock because they saw its long-term potential.
  • Company news.
    • Successful product launches and business expansion are the kinds of good news that could push a company’s stock prices higher. Layoffs, changes in leadership, and product recalls could cause a company’s stock to drop.
  • Industry performance.
    • Companies in the same industry often have similar performance. If an industry, like the tech sector, is doing well overall, there may be more demand for tech companies’ stocks.
  • The economy.
    • When the economy is doing well, companies earn bigger profits, and investors have more money to invest—leading stock prices to rise.
    • If the economy is struggling, profits may be flat or falling, and investors may be nervous about the future—causing stock prices to fall.

Fun fact:

Twitter can have a big influence on the stock market. In 2018, former Tesla chair Elon Musk tweeted that he was taking Tesla private at a price of $420 a share. Tesla was trading at $340 a share at the time.

After the tweet, stock prices rose briefly but plummeted to $240 a share as Musk’s deal fell apart. (Musk also got into trouble with the SEC over the tweet.)

Types of stock trades

The price at which you buy and sell shares may also depend on the type of stock trade. There are two main types of stock trades:

  • Market trades: You buy and sell shares at market price—that is, the stock’s current selling price.
  • Limit trades: You name the price. You might tell your broker that you only want to buy a certain stock if its share price falls below $100. Or, you could choose to sell your stock if its share price rises above $150. Your trade will only go through if the stock hits the price you’ve specified.
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