Why Stock Markets Fluctuate

What makes the stock market fluctuate?

A number of buyers and sellers make a market. At any given point in time, there are bids and offers for a particular stock. The order book which is visible to the investing public shows the spread at which a jobber is willing to buy and sell stocks of a company. The ‘bid’ price is always less than the ‘offer’ price and the difference is the profit margin of the jobber. Investors get the bigger picture by observing the movements of the benchmark indices- the Dow, the Nasdaq, the S & P 500 among others.

The stock market is said to be the barometer of the economy and should ideally reflect the economic conditions of a particular economy. But in the short term, investor sentiment plays a crucial role in price discovery. When there is a preponderance of negative news like downgrading of the sovereign rating of a country, there is selling pressure. People in general perceive it to be an indication that the country’s economy is in trouble. A recent example is the S & P downgrade of France from ‘AAA’ to ‘AA’.

You must have heard market commentators talk about the market being volatile. It means that stock prices are fluctuating wildly within a band during a trading session. There is, in other words, an absence of a trend. Volatility is caused by uncertainty and confusion in the minds of investors suffering alternate bouts of greed and fear. Aggressive traders, who revel in such conditions, compound the crisis of confidence by creating ‘bubble’ volumes or leveraged trades.

Such ‘bubbles’ occur because stocks are priced irrationally based on unrealistic expectations rather than concrete fundamental analysis of its actual worth. Like it invariably happens all bubbles burst when such excesses get corrected as information is analysed correctly.

A classic example of bubbles is the way markets reacted globally on February 27, 2007 triggered by rumors that the Chinese authorities would raise interest rates to curb inflation and clampdown on speculation with borrowed funds. The result: the Chinese markets collapsed nearly 9 per cent in a single session, sending shock waves which destabilized equities across all major markets.

Markets fluctuate because there are multiple sets of investors trading at a given point in the market. There are ‘bulls’ who think the market can only go up, there are ‘bears’ who believe that the worst is yet to come and there are the so-called ‘stags’ who believe in quick gains through rapid trading activity. Market fluctuation is a function of demand and supply for a particular security or buying and selling in a market. Many believe that fluctuations are signs of a healthy and vibrant market.