What causes a stock to go up or down in price?

Well, a stock price rises when there are more buyers than sellers, and it falls when there are more sellers than buyers.

While that sounds like a Smart Alec answer, it’s also not incorrect.

A stock price does increase when there’s more demand than supply and it does decrease when there’s more supply than demand.

However, such a simple answer doesn’t help you become a better or more informed investor.

It is more useful to understand what might cause buyers (demand) to exceed sellers (supply) and sellers to exceed buyers, which in turn causes the stock price to rise or fall.

Look Forward

One main cause of a stock price to jump or fall sharply is a change in expectations about a company’s future revenue and earnings. It’s important to keep in mind that the market is forward looking. The price of a stock reflects the market’s expectation of what is to come.

You may be thinking, if the market doesn’t care about the past, then why does a stock jump when a company beats earnings expectations for a past quarter?

When a company reports better-than-expected earnings, if the share price goes up, it’s because the past strong earnings suggest that the upcoming quarters will be stronger-than-expected.

In other words, market participants have an expectation of what revenue and earnings will be quarter to quarter, when the results for an early quarter is better than expected, then it follows that the expectations for future quarters may be too low as well. This implies the stock is undervalued, and more investors become buyers.

In fact, when a company beats expectations but downgrades its guidance for upcoming quarters, all things equal, the stock price will fall.

Thus, when the outlook for company’s financial performance improves, the market adjusts its valuation as well.

Things Within and Beyond Control

There are various ways a company can improve its outlook. Common ways include launching new products or services that become major successes, improving efficiency through cost cutting, and retiring debt early to reduce interest expense and shore up balance sheet to reduce borrowing costs.

And sometimes, a company (and its stock) is just not on many people’s radar yet. It could be because the company operates in a field that’s relatively new or obscure. Or it’s not followed by Wall Street. Whatever the reason, this kind of stocks offers high potential upside because if there are many market participants who simply don’t know about a stock yet. They could become buyers if the company does well and the stock becomes well known.

A company’s outlook can also change for reasons beyond its control.

For example, the state of the economy plays a huge role. When the economy is booming, the water lifts all boats—some more than others, depending on economic sensitivity. Unfortunately, the opposite is also true. This is why when the probability of a recession goes up, the stock market goes down as more market participants become sellers. On a day-to-day basis, a stock’s movement is usually driven by fluctuating market sentiment.

Government policy and regulation change can also make a big impact. Thus, when Fed Chair Jerome Powell talked about fighting inflation and implying that Fed policy will continue to lean to the hawkish side indefinitely, it sank the whole market. New laws or rules, such as corporate tax rate changes, can impact a company’s expected profitability, and thus affect its stock accordingly.

Other Factors

Besides changes in expectations for a company’s future financial performance, a stock price a can also change when a stock’s multiple expands or shrinks.

For example, a low-growth stock typically trades at a low-PE ratio. But if this company develops a fantastic new product that projects to increase sales by 50% and significantly improves the company’s growth profile, not only will the stock get a boost from the expected higher top and bottom lines, but its earnings multiple will likely also expand, helping the stock go up even further.

Other factors that change a stock price could be a takeover rumor or a stock buyer or seller (such as a hedge fund) who makes a trade so big that it affects the action for that day. There are also many technical traders who don’t care about a company’s fundamentals. They trade based on analysis of a stock’s recent action. These factors are out of the control of the company.

The stock market is a constant tug of war between buyers and sellers. Recall that the market trades based on expectations, which are subjective. Every market participant has his/her own estimate of what a particular stock should be worth. Based on the same information, John may think a stock is worth $30 but Bob may think the same stock is worth $35. Without differing opinions, there would be no market.

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