By now you have a good idea of how the stock exchanges work. It is in these exchanges buyers and sellers meet to exchange their shares. To understand how the price fluctuates in a day, we need to understand a simple concept of demand and supply. I will take you to different real-life scenarios to make you understand this in-depth. The whole stock market hangs on this very basic principle.
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Demand and supply: Artwork
This is where human psychology comes into play. With a simple example, suppose you’re an artist and you draw amazingly well. Since you have this talent you sell your artworks, why waste talent, right? Now your established artist but let’s get back to the olden days. In the initial days, you were selling your artworks for a very less price.
A 10-hour long painting, you were selling for a mere 300 rupee. But as time passed by, you gained experience. With experience, came the demand for your talent, your artwork. People started to recognize your talent and started buying from you. With recognition and demand, came the responsibility to sell your artwork.
Since you have only 24 hours in a day, the artworks you will be selling will be the same 10-hour long artworks. But since the supply is limited, or capped, the people who want to buy your artwork are more (you’re a recognized artist now). Thus, you started to sell your unique artwork now at 3000-4000 apiece.
Here we can see, the supply is fixed or less as you’re the unique artist and demand is more since the number of people wanting to buy your artwork is more. Naturally, by this you start to increase your price and thus 300-rupee artwork is now at 3000-4000 rupee. You can see with demand; the price has increased.
Demand and supply: Onion
This applies to all the vegetables, but since you can find onion in just about any food, I have taken this example. In states like Kerala, where agriculture is very less, we normally import vegetables from other states. It’s the month of May and the price of onion is 50 per kg, you can do plus, minus 10 taking the retail guy's profit. But more or less it's at this price.
In August, heavy rains have come quickly and the crops are no longer able to stand this heavy rush of rain. The crops die out and this also took a toll on the onions stored. As I mentioned, the demand for onions is the same, since all the dishes need onions. If 100 people are buying onions at a rate of 50 a day in the month of May, the same people will buy in the month of August as well.
But, to the twist of events, heavy rains slashed the supply of onion and now there is a shortage of onion. But people need to have an onion to survive, thus, these 100 people is now left with only 50 onions. What happens here is pure human psychology, basically the greed. One person will say, I am willing to pay extra 10 rupees for the same kilo of onion. But the next person also needs onion, he will say, I am willing to pay extra 20 to buy the same kilo of onion.
So, practically, the retailer will sell to the person who bids the larger amount. Thus, the price of onion increases. Even though this sounds simple, this complex chain of events leads to the rise of price of onion. Thus, in the month of august, the price of onion is 100 rupee. Using this psychology, the retailers also increase the price since they are also limited with the number of onions they have in hand. This actually happened in the year 2020, where the prices of onion were close to 100/kilo. What a lovely onion story!
Demand and supply: The stock market
You can relate the above with share price of a company. There are multiple factors that actually drive the share price, but all goes down to demand and supply. Let’s take one share for example. As of today, 7th Oct 2021, the share price of Tata motors skyrocketed 15%. Why? For some time Tata motors have been silently running with not much hypes. But what happened today? The brokers around the world upgraded tata motors rating and increased it target level by a further 40-50% from its current price.
These brokers such as Motilal Oswal, Morgan Stanley is a large firm with 1000’s of analysts. These analysts are most of the time correct. Seeing this, people in India, retail investors and other institutional investors started buying, I mean only buying. The price when Tata motors opened today was 340 and as this news hit, people started buying no matter the price. Since people are confident the price will go way higher, more buying came into play.
You must be thinking then why people are selling in this case, right? Since Morgan Stanley and other bigger firms are from outside India, some people thought it was false impression and the price is almost overpriced now. The people with this belief started to sell. But, as I said, people were ready to buy at any price, thus sellers sold at a higher price, thereby taking sellers profit and taking the price higher. The supply was less, limited to the sellers of 30 Lakh people, but the demand was higher with 1.5 Cr people.
There are multiple factors where people think while selling and buying, the above illustrated is just one of them. So different people having different point of view about the same stock is what drive the price of a stock. Difference in opinion makes one person to think this stock is worth buying while the other think it’s worth selling.
Investor Analysis: Overvaluation and Undervaluation
This is the same as valuing a price of a product based on your assumptions and thinking. Suppose your buying a watch for yourself and looking at the watch you think the watch is not worth the price. This means the watch is overvalued based on our thinking. While your sister sees the same watch, tries it on and is super excited as she believes the watch is worth every penny. The contradicts your decision, where you don’t want to buy, but your sister goes on and buys the watch.
For example, LIC of India is one of the largest investors in India. Yes, all those LIC policies you take, those money is actually invested in the stock market. There are analysts who read companies reports, looks into external factors, company performance, etc to evaluate the share price. If the analyst thinks the price of the company is less for what he is buying, he will probably go ahead and buy. And LIC doesn’t buy in thousands of rupees, they usually buy in 1000-5000 Cr worth of shares in a single go, or multiple goes.
The same can be done for undervaluation also. When reliance communication was struggling during 2018-2019, it valuation dropped, people feared the worst and company was going into bankruptcy. Here people were thinking the company is overvalued for the price and started selling their shares, bringing the price even lower.
One of the main reasons why humans emotions come into play is when people are greedy and feared. The price moves up when people are greedy and buys, while it moves down when people are fearful, panicked and sells off. When you see a sudden fall of 6-8% for a stock in a day, most of the time news will be the number one factor.
The very best example is Tata motor in the beginning of July 2021. There were rumours of chip shortage around the auto industry. Tata motors said, that the chip shortage issue will result in 50% lower wholesale volume than planned. That one single day, Tata motors share plummeted by 10% from the level of 350.
As the name suggest, the psychology of the market participants, individually and collectively, is what move the market. Market sentiments is often biased, subjective and controversial. This is a type fo behavioural finance and we tend to overemphasise data that comes easily to our mind.
We can relate this during our Covid time, the initial phase of covid during beginning of 2020. People were panicked and didn’t knew what was happening. millions of people were dying around the world, and no one knew what the future of companies could be. So, in a fearful and panicked mode, everyone started selling the shares. And shares all around the world saw a steep downfall.
Key Events which impact the stock market
Apart from the above said, there are other key events which has a major impact in our stock market. Remember, its people who drive the price up and down. And what makes people to buy and sell is the fear and greed in them. When a key event, policy change happens, market participants tend to react to these changes thereby bringing the price up or down. Lets look at some of these events.
The monetary policy is a tool with which the reserve bank of India (RBI) controls the money supply by controlling the interest rate. RBI lends money to banks and corporates. Suppose RBI increases the interest rate, the corporate can’t borrow easily, if they cant have money, then they wouldn’t grow, this slows down the economy.
If the interest rate is less, corporates and banks borrow more money for their growth, thus driving the economy forward. But with this, there will be surplus money in the economy which drives inflation as well. Higher inflations rates slow down our economy.
RBI meets every quarter to review this rate. This is a key event where the markets participants watch out for. The first to react to these rate changes will be sectors sensitive to interest rates like banks, automobile, housing finance, real estate, metals, etc.
Inflation is the sustained increase in general prices of goods and services. If inflation increases, the prices of goods/services increase, thus less people will buy, as a result the companies will perform less.
If inflation decreases, the prices of goods decrease, people will buy more, but there will be surplus money in the economy, which leads to instability in economy. Thus, our RBI needs to find the right balance between increasing and decreasing inflation. In India, normally, the inflation rate is between 3-4%.
This is a key event during which the ministry of finance discusses the country’s finance in detail. During the event, major policy announcements and economic reforms are announced which has an impact on various industries across the markets.
For example, in a budget, the finance minister raised the duties for cigarettes, and hence the prices of cigarettes were also increased. An increased price of cigarette has a few impacts.
This discourages smokers from buying cigarettes and hence the profitability of cigarette manufacturing companies such as ITC decreases. If this happens, investors who has invested in ITC may think about selling their shares. In fact, when this actually happened, ITC traded 3.5% lower for this precise reason.
Corporate Earnings Announcement
The listed companies are required to declare their earning numbers once every quarter, called the quarterly earnings. During this, the company gives out numbers related to revenue generated, expense managed, taxes and interest charges, profitability in that quarter, etc. Additionally, they also give future forecasts of the company called ‘corporate guidance’.
The investors and market participants match the company’s quarterly report earning with their own calculated earnings. They match this in order to know their expectations from the company and how the company should have performed. The market participants expectation is called ‘street expectation’.
If the earning is better than the street estimation, then the stock price react positively, and negatively if the numbers are below street expectations. If the street expectation and numbers match, then you wouldn’t see any changes unless there are surprises.
Now you should have got an understanding on how the prices fluctuate in a daily basis and in a longer terms basis. How people think differently, and how human factors such as fear and greed drive the stock market. Since you got an understanding of how our emotions work. You must be excited to start your journey into the stock market. For that you basically need 3 accounts. Wait, account? You mean a bank account? Well, no. Lets explore what are these accounts you need in order to start investing in the next article.