Ever wondered about the science behind why markets change? How does investing work? And how do shares work?
All shares including shares in blue chip companies (which are generally considered large, stable and reliably profitable companies such as those in the ASX20) generally appear to move around often throughout the day.
While we don’t have a crystal ball, and we don’t always know exactly when, and by how much shares can move, it is our view that there are some tell-tale signs.
Digging a little deeper and understanding some of the reasons why share prices move may provide some clarity around how shares work.
Supply and demand
Shares are bought and sold around the clock on stock markets around the world. And this determines the share price.
Supply refers to the number of shares people want to sell and demand is the number of shares people are looking to buy.
If investors favour a particular share or company, we find that they generally want to buy shares in it. This generally drives the demand and price up.
For instance when Facebook went public in 2012, it initially flagged its debut share price at $28 to $35 per share, but given the increasing hype from investors, it increased its target to $34 to $38 each. Mounting interest eventually drove the share price up further, with Facebook’s first share trade sale at $42.05.
Conversely, if a company is not in favour, the price may also fall, as we find that investors generally opt to sell their shares.
We find that often the outcome of the current share price is what investors feel a company is worth.
This is different to a company’s value or market capitalisation. Market capitalisation can be explained like this. For example say Jane Groceries’ has 10 million shares outstanding, each worth $2.51 - by multiplying the number of shares (10 million) and price of those shares ($2.51), we can determine the market cap for Jane Groceries’ is $25.1 million.
News – good, bad and unexpected
Positive, company news can drive the share price up, as investors generally look to take part in a company’s success.
In 2016, Google’s share price hit a high (at the time), when the market cheered the sleek new design and launch of its new smartphone, Google Pixel.
At the same time, poor or unexpected news which relates to the company whether it’s lower than expected earnings, corporate governance, a restructure or sudden key departure can prompt investors to quickly sell their holdings and run the share price down.
You only have to look at Ardent Leisure (owner of Dreamworld) after the announcement of four fatalities at the theme park in 2016, to see how unexpected news appears to impact the reputation of a company including its share price. The share price of Arden Leisure the day before the fatalities was $2.55. That price fell to $2.00 (down 22 per cent) the day after the fatalities were announced.
Announcements and legislation
Changes to legislation and political announcements can also affect investor sentiment, and investors’ decisions to buy and sell shares.
For instance, we believe that when the $6.2 billion bank levy was announced during the 2017 Federal Budget, the market took notice.
The bank levy proposed to slug Australian banks (with more than $100 billion in liabilities) was a levy imposed to ensure the "banking sector makes a fair contribution to the economy.”
The run-off effect post the announcement was that $14 billion was wiped off the banking market.
Aside from company specific or industry news, broader political events can also affect share movements.
Take the recent fallout from key resignations amidst Theresa May’s Brexit deal. This appears to have caused shares exposed to the UK, as well as the Pound, to tumble.
As you can see there are a number of factors which can influence the movement of shares.
And it’s handy to know what causes shares to move about. To help put your mind at ease and to help prevent any knee jerk reactions caused from market speculation or otherwise, which could prompt you to sell shares too quickly, we find that a common strategy is to ensure you are properly diversified.
Diversifying your investments can help to smooth out your investment returns and to reduce the risk of any particular event on your portfolio. Remember that it is a good idea to always seek independent financial and legal advice before investing.
If you want to know more, explore our investing series.