This investing is sometimes done through a broker-dealer. Increasingly, this is done through a firm that is a registered investment advisor RIA.
An RIA is bound by a fiduciary duty to put the interests of clients above the interests of the firm. Thanks to the capital markets, you can pay someone else to handle your portfolio. You can spend more time generating income and less time reading K filings or mutual fund prospectuses.
After shares of a company's stock are issued in the primary market, they will be sold—and continue to be bought and sold—in the secondary market. Stock price fluctuations happen in the secondary market as stock market participants make decisions to buy or sell. The decision to buy, sell, or hold is based on whether an investor or investment professional believes that the stock is undervalued, overvalued, or correctly valued.
It comes down to the supply and demand in relation to the volume of shares being bought and sold. It's the investors, or partial owners, buying and selling among themselves that determine the current market value of a trade. The potential buyers announce a price they would be willing to pay, known as the "bid.
When a buyer and seller come together, a trade is executed, and the price at which the trade occurred becomes the quoted market value. That's the number you see across television ticker tapes, internet financial portals, and brokerage account pages.
While the ask and bid essentially create a stock's price, that doesn't touch on bigger issues like why a seller was willing to sell at a given price, or why the buyer was willing to pay a certain amount.
Some people don't think there's a point in asking those deeper questions, and that kind of thinking is known as Efficient Market Hypothesis. The theory is that a stock price reflects a company's true value at any given time—regardless of what analysis of the company's fundamentals or broader market trends might suggest.
EMH believers are proponents of passive investing, a strategy that takes a broad and neutral approach, as opposed to focused analysis and timing. The thinking is that no amount of research could predict the randomness of the market, so it's best to buy as broad a range of stocks as possible and hold onto those stocks for as long as you can.
EMH is not a universally accepted theory, and it's actually highly controversial in some investing circles. On the other side of the theoretical spectrum, you'll find Intrinsic Value Theory. This theory states that companies trade for more or less than what they are worth all the time. The company's real value, something Benjamin Graham called "intrinsic value," is the net present value of the owner's earnings.
It is the cash that can be extracted from the enterprise from now until the end of time, based on the actual productive capacity of the business itself.
In other words, how much money is the company making, and how long can it continue making that amount? Investors that follow this theory are " value investors.
His widely attributed quips draw from this outlook, including his belief that "if a business does well, the stock eventually follows," and "it's far better to buy a wonderful company at a fair price than it is to buy a fair company at a wonderful price. In order to understand how stock prices are determined, it's important to first know how the capital markets work.
Within the capital markets, buyers and sellers collectively help determine the stock price. There are many factors and theories on why stock prices fluctuate, but two theories are the most cited. The Efficient Market Hypothesis says that a stock price reflects a company's true value at any given time.
The Intrinsic Value Theory states that companies may trade for more or less than they are worth. During a stock's initial public offering IPO , the market has not yet had a chance to determine a stock's value. The initial stock pricing is usually decided by the investment bank underwriting it, based on the value of comparable stocks, company financials, experience, and sales skills.
The main factor that determines the price of a share is supply and demand. As the terms suggest, supply refers to the availability of the particular share, and demand is the desire for it.
Low supply and high demand raise the price of a share, while high supply and low demand lower it. When news and reports show good performance of a company or forecast growth in its sector, demand for its shares grows and the stock price rises accordingly. On the other hand, negative news and forecasts will cause the demand to decline; investors would be less likely to buy shares and more likely to sell them off, which would in turn increase supply of the share in the market and lower the price accordingly.
Publicly traded companies are required to publish reports that include their recent earnings, current cash flow, and performance forecasts. Dividend announcements can also influence the share price. If dividends are higher than expected, then share prices tend to increase and vice versa.
If leadership is capable and stable, and the company is known to have a robust social responsibility policy, then it is generally considered a company likely to continue to grow and succeed. Share prices tend to rise during economic booms and tend to fall during recessions.
Interest rates also affect share prices. In lower interest rate environments, investors will generally look for better returns in higher-risk assets.
When economies slow down, or political tensions break out, or a new virus spreads across the globe, a sense of panic can take over the markets, and many investors end up selling their investments to try and limit potential losses. But by panic selling, all investors are doing is pushing share prices down and making their losses real.
And think about it. If prices are being pushed down by panic selling, this means that investments are getting cheaper. So why not possibly grab the potential bargains? That way, if markets and the value of your investments rise, you could be making a gain. Invest now. Can we expect prices to always move?
Most of the time, share prices will move steadily. But sometimes, prices will swing quickly and abruptly. This is exactly what happens when markets drop , and we would typically talk about high volatility. But what causes share prices to move that much? Investors are undeniably human, meaning they can be quite emotional.
And the thing with emotions is that they can lead you to make irrational decisions.
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