It is difficult to identify specific factors that influence the market as a whole. The stock market is a complex, interrelated system of large and small investors making uncoordinated decisions about a huge variety of investments. The market, so to speak, could be construed as sort of an ecosystem, one organized by the invisible hand. Each market participant acts and plays freely using their individual ideas and by following their own personal interests. The market is shorthand for the collective values of individuals and companies.
There are basic economic principles that can help explain any up and down market movements, and with experience and data, there are more specific indicators market experts have identified as being significant.
The Basics: Supply and Demand
In a market economy, any price movement can be explained by a temporary difference between what providers are supplying and what consumers are demanding. This is why economists say that markets tend towards equilibrium, where supply equals demand. This is how it works with stocks; supply is the amount of shares people want to sell, and demand is the amount of shares people want to purchase.
If there is a greater number of buyers than sellers (more demand), the buyers bid up the prices of the stocks to entice sellers to be willing to sell or produce more. Conversely, a larger number of sellers bids down the price of stocks hoping to entice buyers to purchase.
Individually, security instruments like stocks and bonds are dependent on the performance of the issuing entity (business or government) and the likelihood the entity will be valued more highly in the future (stocks) or be able to repay its debts (bonds).
Widely Accepted Market Indicators
This begs a new question: What creates more buyers or more sellers?
Confidence in the stability of future investments plays a significant role in whether markets go up or down. Investors are more likely to purchase stocks if they are convinced their shares will increase in value in the future. If, however, there is a reason to believe that shares will perform poorly, there are often more investors looking to sell than to buy.
Events that affect investor confidence include:
- Wars or other conflicts
- Concerns over inflation or deflation
- Government fiscal and monetary policy
- Technological changes
- Natural disasters/extreme weather fluctuations
- Corporate or government performance data
- Regulation or deregulation
- Changes in the trust of whole industries such as the financial industry and MBS case study
- Changes in the trust in the legal system
For example, the largest single-day decrease in the history of the Nasdaq Composite Index took place on March 16, 2020. The market lost (traded down) 970.28 points, over 12% of its value. This move is attributed to the COVID-19 pandemic, which created a lot of uncertainty about the future. Therefore, the market had many more sellers than buyers.
Interest rates are also believed to play a major role in the valuation of any stock or bond. There are several reasons for this, and there is some debate about which is most important. First, interest rates affect how much investors, banks, businesses, and governments are willing to borrow, therefore affecting how much money is spent in the economy. Additionally, rising interest rates make certain safer investments (notably U.S. Treasuries) a more attractive alternative to stocks.