Wrapping your mind around the idea that the stock market is a constantly changing entity can be a difficult task for many investors. In fact, for some people, this fact can be a deterrent that keeps them from investing their money. With reference to this fear, many new investors often ask the question: how can I invest in a market that could be completely different 20 minutes from now? But, by applying the basic principles of supply and demand, it can become much simpler to understand the stock market and its frequent changes, making it less scary to invest.
Effectively, prices in the stock market constantly change because investors’ demands for those stocks are constantly changing. Thus, the market prices for stocks are directly related to the number of investors that want to buy shares and the number of shares that are available to be purchased at any given time. In this sense, having an understanding of the stock market is not much different from having an understanding of any other normal business. Just like in any standard business, if a product is good, people will want to buy it. Then, if people want to buy it and the supply is limited, the price of that product will likely rise.
The only difference between a regular business and the stock market is that, in the stock market, shares do not only have one standard price. Take, for example, a standard Honda Civic, which starts sale at a dealership at $18,000. Of course, buyers can add extra packages and alter this good, which might change its price, but if they want to buy just a plain Honda Civic, they will spend about $18,000. Through this example, we can see that many standard goods sell for a constant price.
Contrastingly, in the stock markets, there is often no one price that a share might sell for – because its selling point is not determined solely by the company that releases the shares. Instead, its price is determined by every investor who decides to sell his or her shares at a given time. Because there are many shareholders who might each “value” their shares in a company differently, the same shares will sell at an entirely different range of prices over time. In other words, as opposed to the set price for a standard Honda Civic at $18,000, the price of shares might vary based on the one particular group of sellers who are selling them.
Further, unlike tangible goods, shares of stock do not depreciate, meaning that they do not gradually lose value over time unless the factors of supply and demand tell them to do so. Thus, at any given time, the “supply” of a stock in the market refers to the number of the same shares that shareholders are willing to sell at their current price.
Then, the “demand” for a stock refers to the total number of potential stock-buyers who might be willing to purchase the stock at its current price. Essentially, just as some investors might be willing to only sell their shares at a certain price, others may only be willing to buy shares at a certain price.
These two principles create the constantly changing world of the stock market. As some investors wish to sell their shares, others are willing to buy them. At certain times, more investors might be willing to sell than those who are willing to buy. Then, at other times, more investors might be willing to buy shares in a certain company – such as if the company releases a promising new product. These supplies and demands change all the time.
Ultimately, as economic theory holds, this process should work until the market reaches “market equilibrium,” meaning the price and supply are unchanging and exactly enough to balance each other out. However, because of the changing nature of human consumption, reaching this “market equilibrium” likely only occurs for a short period before the supply or demand of a shock changes and the process begins again. But, by understanding this process more thoroughly, it is simple to see how the market’s movements are not simply uncalculated or random, but instead change according to common market forces. This understanding can definitely help to reduce the fear of the changing markets!