Keep an eye on the factors that cause volatility in stock markets

What moves the stock market?

Hi there,

That question has many answers. Economic factors like GDP and earnings reports, political factors like government policies and political unrest, commodity prices like price of crude oil and gold, social issues like war and terrorism, acts of God such as earth quakes and flood may cause the market to change direction or speed up or slow down its momentum.

Most common of them are listed below.

  • Inflation, Interest rates & Earnings
  • High Speculative activity
  • Demand and supply
  • Oil/Energy Prices ,War/terrorism , Crime/fraud
  • Serious domestic political unrest
  • Uncertainty

Inflation, interest rates & Earnings

To put it in simple terms, Inflation is a sustained increase in the general level of prices for goods and services. There may be a lot of reasons for this. It is measured as an annual percentage increase. As inflation rises, every Rupee in your wallet buys a smaller percentage of a good or service. People living off a fixed-income, such as retirees and salaried class see a decline in their purchasing power and, consequently, their standard of living. Uncertainty about economic future makes corporations / consumers spend their money cautiously. This hurts economic output in the Long run

As inflation increases, Reserve bank increases the interest rates to reduce the money supply and slow inflation down: When interest rates are high, people find it expensive to borrow, and therefore there is less money floating around. When interest rates are high; people require higher returns on stocks. Its not so easy to just increase earnings for a stock, so its price has to adjust downward.

For example : Consider a stock that sells at Rs 100 with earnings of Rs 12, a 12% return. When Fixed deposits pay 8%, an investor may be willing to buy this stock for the extra 4% return. However, if interest rates were to rise, to say 12%, who would pay for this 12% return, when they could get 12% risk-free by Fixed deposits ? Therefore, the stock may drop to Rs 75. With earnings of Rs 12, this now generates a 16% return and is once again at a price where an investor might be willing to take the risk on this stock for the extra 4%.

Mismatch between actual earnings and expected earnings of the corporates may cause the stock markets to fluctuate. That’s because, when the corporates report week results than expected, the investors react by selling of their holdings in that stock resulting in a huge drop in stock prices. The opposite is also true. If corporates come up with better than expected earnings results, more an more investors would invest in those stocks resulting in a surge in stock price.

Speculators and investors

Anyone who owns shares are generally referred to as ‘investors’. However, not everyone is an investor in share market. There is one category of buyers who do not follow the fundamentals – Speculators. Excessive  use  derivative instruments like options and futures to speculate may drive stock prices to extreme levels defying all logic. Speculators are largely responsible in creating  heavy volatility in the stock markets. Since they buy securities based on momentum, it leads to stocks becoming dramatically overvalued when everyone is interested and unjustifiably undervalued when the craze ends.

Demand and supply

The very basic economic theory of demand and supply holds good in stock markets too. When there are more shares available than demand, each of those shares is worth less. The opposite is true when there is more demand than shares available.

Oil prices/fraud /scams and other factors affecting stock markets
There are many other factor like hike in Oil prices (resulting in commodities and services getting dearer) war and terrorism (Example: The sept 11 attack and the uncertainty it created in stock markets around the world) Fraud / scams (Example :- Satyam’s case) serious political unrests which results in certain commodity prices moving up ( or revenues of a particular country decreases) which might result in stock prices crashing down.

CONCLUSION

If you have decided to become active in share markets, it’s important to know what moves the stock market. Events like those mentioned above create golden opportunities to buy shares of good companies at throw away prices.

You may like these posts:

  1. What drives the stock market ?
  2. Using Beta to gauge volatility.
  3. Some truths about stock markets

2 Responses to “Keep an eye on the factors that cause volatility in stock markets”

chinmay malik

July 2, 2013 at 11:05 pm

your article is not only important for beginners but for every investors. These are the base share market knowledge.

Roshan

August 10, 2014 at 5:56 pm

Great work

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