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Know Why Stocks Fluctuate in Value

There are many different reasons why stocks fluctuate in value. The most common reasons for fluctuations include changes in interest rates; the perceived risk of the company; company earnings, dividends, and cash flow; supply and demand; and investor sentiment in the market.

Interest rates: Investors require a certain expected return, or discount rate, to invest in stocks; this discount rate is greatly influenced by the interest rate. As interest rates decrease, shareholders’ discount rates also decrease; future earnings are therefore discounted at a lower rate, which results in a higher value of the company. As interest rates increase, shareholders require a higher discount rate to invest; all future earnings are therefore discounted at this higher rate, which reduces the value of the company.

Perceived risk of the company: There is an inverse relationship between perceived risk of the company and its stock price; this is because as the perceived riskiness of the company decreases, investors are willing to pay more for the company stock: this results in an increase in stock price. As the perceived riskiness of a company increases, investors are willing to pay less for the stock: this results in a decrease in stock price.

Earnings, dividends, and cash flow: As earnings, dividends, and cash flow per share increase beyond investor expectations, investors are willing to pay more for the stock, and the stock price generally increases. As earnings, dividends, and cash flow per share decrease below investor expectations, investors are less willing to pay for the stock, and the stock price decreases.

Supply and demand: Stock prices may rise and fall based solely on supply and demand for the shares. For example, an investor with a large number of shares may need to sell shares of a stock to meet his or her cash needs. When the shareholder sells these shares, the supply of shares that are for sale increases, and the price of the shares is likely to fall. Likewise, if an investor gets new money into his or her accounts and decides to substantially increase his or her holdings in a stock, the price for that stock will likely rise as demand increases.

Investor sentiment in the market: Stock prices may rise or fall based on the general sentiment that investors have about the market and about how well the overall market is performing. If investor sentiment is positive and the market is performing well, investors will likely bid up the price of all stocks. If investor sentiment is negative and the market is performing poorly, investors will typically be less willing to purchase stock, resulting in lower stock prices.


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