Interplay of fundamental and technical factors in stock prices
The price of a stock, it is said, is a function of demand and supply at any given point in time. This hypothesis holds true, provided there are no extraneous factors at play. While the second-by-second fluctuation in stock price may have nothing to do with any change in the fundamental factor, the overall demand-supply equation is the function of fundamental factors that go a long way in the determining the price level of a stock.
Fundamental factors such as demand for the product or services, financial performance of the company, management bandwidth, business prospects, competitive environment, sectoral and overall economic outlook play an important role in determining the price at which market participants are willing to trade the stock at a given point in time. A change in any of these fundamental factors changes the sentiments of the investors towards the company, which can lead to a drastic revision in the stock price. So, when a company bags a huge order, investors reckon that the company’s profit would receive a big boost and there is a mad scramble to buy the stock. The huge increase in the demand for the stock results in a huge jump in the stock price.
On the other hand, if there is a big mishap such as fire or explosion in the company’s factory, which may lead to the closure of the factory for a few months, this would result in a large financial loss to the company which would be seen as a big setback for the company. In such a case, every investor would like to exit from the stock and there would be a huge selling spree. The huge increase in the supply of the stock would lead to a vertical fall in the price of stock in a matter of minutes. The same happens when there is some sector-specific news or when there is a significant change in the government’s policy in respect of the business in which the company is operating.
However, one may witness wild fluctuations in stock price movement that have nothing to do with either fundamental or technical factors. Such high volatility in stock prices arises due to price manipulation by some of the operators in the market, which was mentioned in the beginning of this article as an extraneous factor. These operators can jack up the price or hammer down the price of a stock by acting in concert, whereby these operators buy and sell the stock to each other to move the price in the intended direction. In market parlance, this is called ‘circular trading’. The jacking up or hammering down of stock price usually happens in small-cap and mid-cap stocks where the free float is low which makes it easy to manipulate. Such wild movements in stock prices usually happen on low volumes and investors need to be wary of such wayward changes in prices.