The power of supply and demand on stock prices
Investors’ magazines provide countless explanations for why stock prices fluctuate as they do. You will hear about the influences on stock prices such as earnings or the economy or credit markets. While these factors affect buyers and sellers of shares, in reality they have minimal direct impact on prices. These and many other factors change the balance between supply and demand. Share prices are a direct result of supply and demand. All other influences such as liabilities, balance sheets, earnings and so on affect the desirability of owning (or selling) a stock. If a company surprises shareholders with low profits, demand for the stock may wither. When it does, the equilibrium between buyers and sellers of the stock changes. Future buyers will demand a discount on the stock’s price and many sellers will be motivated to accept. More sellers than buyers means that supply exceeds demand, so the price falls.
Prices are falling
At some point, a stock’s price will fall enough for buyers to find it attractive. There are many factors that can change this dynamic. When buyers enter the market for a stock, demand grows faster than supply and so the price will increase. Often, supply and demand find equilibrium at a price that buyers accept and sellers accept. When supply and demand balance, so that they are roughly equal, prices will spin up and down in a narrow price range. We can find many examples of stocks staying in a steady range for days or months before an event upsets the balance between supply and demand. If demand for a stock exceeds supply, its price will rise. However, it will only rise to the point where buyers find the price attractive. After that, demand will usually decline. As we know, falling demand will cause shareholders to sell. When owners sell (for whatever reason), the price will fall because there is now more supply than demand. By lowering the price, sellers of the stock hope to encourage someone to buy it. The dynamic works exactly the same when demand increases but in reverse. When the price falls, it will reach a level where buyers find the stock attractive and demand increases. When investors start buying, the price of the stock will rise because more and more sellers need to be enticed to sell their shares. This mechanics of supply and demand is the most important truth that new investors need to learn about stock prices. It is the give and take between supply and demand that sets the price.
Who can influence the supply-demand balance
Only institutions such as mutual funds, pension funds and banks trade in sufficient volume to influence stock prices. These large transactions drive prices up or down depending on the number and speed with which they buy or sell shares. Stocks are subject to the law of supply and demand as much as any other product. Identifying stocks with the right technical indicators to justify institutional buying or selling is crucial to finding stocks that are poised to make large price movements.
“It takes a lot of demand to move the price up, and the biggest source of demand for stocks is the institutional buyer by far.” – William J. O’Neil
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