The Power of Supply and Demand on Stock Prices

Investor periodicals supply countless explanations why stock prices fluctuate as they do. You will hear about the influences on stock prices like earnings or the economy or the credit markets. While these factors impact buyers and sellers of stocks, in reality they have minimal direct impact on prices. These and many other factors do is change the balance of supply and demand.

Stock prices are a direct result of supply and demand. All the other influences like debt, balance sheets, earnings and so on affect the desirability of owning (or selling) a stock. If a company surprises stock owners with low earnings, demand for the stock may wither. As it does, the equilibrium between buyers and sellers of the stock is changed.

Future buyers will require a discount in the stock’s price and many sellers will be motivated to accommodate. More sellers than buyers means that supply will exceed demand, so the price falls.

Prices Drop

At some point, a stock’s price will drop enough that buyers will find it attractive. There are many factors that can changes this dynamic. As buyers move into the market for a stock, demand grows faster than supply and so the price will increase.

Often supply and demand find equilibrium at a price that buyers accept and sellers accommodate. When supply and demand balance, so they are roughly equal, prices will gyrate up and down in a narrow price range. We can find many examples of stocks staying in a flat range for days or months before an event disrupts the supply/demand balance.

If demand for a stock exceeds the supply, its price will rise. However, it will only rise to the point where buyers find the price attractive. After which, demand will typically wane. As you know, declining demand will cause stock owners to sell. As owners sell (for any reason), the price will fall as there is now more supply than demand. By dropping the price, sellers of the stock hope to encourage someone to buy it. The dynamic works just the same when demand increases but in reverse. As the price falls, it will reach a level where buyers find the stock attractive and demand will increase. When investors start buying, the stock’s price will rise as more and more sellers need to be enticed to sell their shares.

This mechanics of supply and demand is the most important truth that new investors need to learn about stock prices. It is the the give and take between supply and demand that sets the price.

Who can Impact the Supply Demand Equilibrium

Only Institutions like Mutual Funds, Pension Funds and Banks trade in sufficient volume to impact stock prices. These large transactions drive prices up or down depending on the number and speed with which they buy or sell stocks. Stocks are subject to the law of supply and demand as much as any other product. Identifying stocks with the proper technical indicators to motivate institutional buying or selling is critical in locating stocks that are ready to make large price moves.

“It takes big demand to move price up, and the largest source of demand for stocks is by far the institutional buyer.” — William J. O’Neil