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Why do stocks behave the way they do? - Views on News from Equitymaster
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  • Aug 26, 2011

    Why do stocks behave the way they do?

    The first thing that pops out while thinking about the stock markets is -Stocks are risky. Surely, they are. However, the reason that the stock prices fluctuate is quite complicated to understand. More often than not, stock prices are affected by multiple factors from global events to company specific reasons. Let us discuss some of them.

    World Events

    Global events such as war, civil unrest, natural disasters or terrorism can impact stocks in the short as well as long run. For instance whenever there is a concern of war among countries, commodities tend to rise while stocks tend to fall. Another example of a global event would be the terrorist attack on the twin towers in the US. This had huge consequences, not only for the US stock markets but also for the other stock markets. Stocks fell across the globe as the global uncertainty increased. However, an offshoot to this event was that the US government subsequently invested huge sums in the defense sector. This fuelled interest in stocks of companies manufacturing military and equipments in many countries.

    Inflation, Interest Rates, Exchange Rates

    Inflation, interest rates and exchange rates also have a bearing on the movement of indices. If interest rates are moving up due to factors like higher inflation among others, participants tend to move towards stocks of companies having low debt. It is like trading away the high risk stocks for the ones with lower risk. If interest rates further increases, a shift towards bond markets is also a possibility.

    Foreign flows have always influenced Indian stock market. The global financial crisis and its impact on global markets is a classic case in point. Indian foreign currency rates (eg: INR / USD) have a direct impact on the stocks prices in foreign countries (eg: USA). Sitting in the US, depreciating rupee (INR) makes buying Indian stocks cheaper. And this can have a positive impact on stocks in India.

    Stock specific events

    Stocks are also affected by events that are more specific to the companies or the services it provides. For instance an oil exploration company discovers new oil blocks, a technology company builds a new product or a pharma company discovers a novel drug. Such stock specific events can have a significant impact on stock prices.

    To sum it all, factors like global events, macroeconomic indicators and stock specific events among others have an impact on the stock prices which many a time leads to volatile swings in the markets. Add to this the unpredictability of human behavior and the practice of timing the markets and predicting daily stock price movements becomes a very futile exercise indeed. What matters while choosing stocks, is the quality of earnings, strong business fundamentals and the strength of the management. That is why a depressed stock market environment becomes a perfect opportunity to pick up stocks with the above mentioned attributes at bargain prices. While stock prices in the short term tend to be volatile and may not reflect the intrinsic value of the company, in the longer run, prices tend to catch up. In short, if the companies perform their stock prices will follow.



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