Stock prices represent the value of ownership in publicly traded companies. Often, market participants analyse them to understand investors' perceptions of company performance and future prospects. Also, stock prices influence corporate decisions and the overall market sentiment.
But how are stock prices determined? Let us understand the process of price discovery in detail and learn the various factors that directly influence the share prices.
How a share price is determined in India?
In financial markets, share prices are determined by the market forces of supply and demand. The market participants, both individuals and institutional investors, express their demand for shares based on their assessment of the:
- Company's prospects
- Industry conditions, and
- Overall market sentiment
This demand is fulfilled by the existing shareholders willing to sell their holdings. In a way, it creates an interaction between:
- Buyers who are looking to purchase shares
and - Sellers who are looking to sell their shares
Ultimately, this interaction determines the equilibrium stock price at which transactions occur in the market. Now, investors must understand that markets are inefficient. This leads to two possible situations:
Parameters |
Situation I: Demand for shares exceeds supply |
Situation II: Supply of shares exceeds demand |
Meaning |
In this situation, buyers are willing to pay higher prices to acquire shares. |
Here, sellers need to lower their asking prices to attract buyers. |
Impact on stock prices |
An upward pressure on stock prices is created until a new equilibrium is reached. |
A downward pressure on stock prices is created until a new equilibrium is established. |
Also, learn the difference between shares and stocks
What factors influence stock prices?
Before entering or exiting the market, both buyers and sellers make assessments of the market situation. This analysis is usually influenced by a variety of factors that eventually affect the stock price. Let us see some major ones:
Economic factors
- GDP growth
- Economic growth directly impacts corporate profits and, consequently, stock prices
- Higher GDP growth rates often lead to:
- Increased investor confidence
and - Higher stock valuations
- Increased investor confidence
- Inflation rates
- Inflation erodes purchasing power
- It affects consumer spending and corporate profitability
- Lower inflation rates are generally favourable for stock prices
- Interest rates
- Interest rates influence:
- Borrowing costs for companies
and - The opportunity cost of investing in stocks versus fixed-income securities
- Borrowing costs for companies
- Usually, lower interest rates stimulate investment in equities and increase stock prices
- Interest rates influence:
Company-specific factors
- Earnings performance
- The financial performance of individual companies is a major driver of stock prices
- Positive earnings often lead to stock price appreciation
- Management quality
- Investor confidence in company management also affects stock prices
- A company’s stock price fluctuates due to:
- Changes in leadership
- Corporate governance issues
- Scandals
- Competitive positioning
- Companies that enjoy higher stock valuations usually have:
- Strong competitive advantages
- Innovative products
- Effective marketing strategies
- Companies that enjoy higher stock valuations usually have:
Market sentiment
- Investor sentiment
- In the short-term, stock prices also get influenced by:
- Investor perceptions
- Emotions, and
- Overall market sentiment
- Usually, “positive news” drives up buying activity
- This pushes stock prices higher
- On the other hand, “negative news” leads to selling pressure and price declines
- In the short-term, stock prices also get influenced by:
Also read: Dividend stocks
How do market participants influence stock prices?
Financial markets particularly witness two broad types of market participants:
- Investors
and - Traders
Their behaviour and trading styles significantly impact stock prices. Let us see how:
Investors
Behaviour |
Trading styles |
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Traders
Behaviour |
Trading styles |
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Conclusion
For investors, it is crucial to understand how a share price is determined. In the financial markets, they are discovered by the interaction of supply and demand. Factors such as economic conditions, company performance, and investor sentiment influence this interaction. Furthermore, the types of market participants also impact the stock prices. Investors with a long-term focus on fundamentals provide stability to the market, while traders with short-term strategies contribute to price volatility.
Do you wish to avoid major short-term price fluctuations? Learn what are blue chip stocks and explore their major advantages.
