The yoyo effect on capital markets – Why share prices fluctuate
You’ve probably heard it before. Interest rates are around zero or even negative, and inflation is rising, meaning your savings are dwindling as we speak. As a result, you’re considering investing some of your spare money in the stock market. But the thought of fluctuating stock prices and the associated risk keeps you away. In this article, we’ll explain why stock prices fluctuate in the first place (sometimes wildly) and why this is nothing you should worry about.
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Short Share Recap
When you buy a share, you become a shareholder. This means that you now own a share of a company. As a reward for investing in a share and accepting the associated risk, you receive a dividend, which depends on the company’s success. In addition, you profit if the value of the stock increases, and you can sell it again at a profit. In our article The five biggest investment buzzwords you can read what exactly shares are.
Bull and Bear
The allegory of a bull and a bear describes the stock market. A bull market represents a rising trend. Investors are confident and encouraged to buy. The economy is usually strong, and unemployment is low. More specifically, in a bull market, the value of the market is up 20% from its high for the year.
A bear market is the opposite of a bull market: the market is down 20% from the high for the year. This is characterized by investor pessimism, which can cause prices to fall further, adding to the negative sentiment.
If you think about the fighting behavior of the two animals, you can easily remember the meanings. The bear strikes downward with its paw; the bull thrusts upward with its horns.
Supply and Demand
Price fluctuations are normal with shares. Think of the stock market as a massive auction where investors simultaneously bid for other people’s shares and offer their own for sale. The buying and selling of shares occur on the capital markets, i.e., the international stock exchanges. If demand exceeds supply, the share prices rise. More people, therefore, want to invest in a company than there are available shares – driving up the share price. Conversely, the price falls when people want to get rid of their shares. That’s why the price of shares constantly changes, even every second in the case of frequently traded shares. Apple’s shares, for example, are traded on average almost 30 million times a day. This means that over 1000 bids are placed every second!
Why do share prices fluctuate?
Since there is a limited supply of shares, bidders compete with each other. As a result, the more popular a share is, the greater the demand and the less willing current shareholders are to sell these same shares. As a result, the share price rises. But, of course, this also applies in the opposite direction. If interest in a share wanes, as was the case for Gamestop, for example, there is less demand for this share, and at the same time shareholders want to sell these shares – the share price falls.
The interest of investors thus determines the price of a share. Whether consciously or unconsciously, investors incorporate every new piece of information into their impression (and therefore purchase or sale) of a stock. This information ranges from earnings reports, the share price, news, press releases, court documents, deceased news, tweets, social media posts, and the general hype. Depending on how investors react to new information, they decide to buy, hold or sell a stock. These reactions cause fluctuations in the stock price.
Now imagine that this supply and demand cycle is repeated every day for millions of investors and stocks worldwide, giving you an idea of the mechanisms that influence daily stock price fluctuations. Since predicting the behavior of these largely irrational people is almost as unlikely as dying as a lefty because you misused right-handed products (probability 0.00014%), it is advisable not to do so either.
The yoyo effect – diets are superfluous
So unless you have a fortune-telling ball from which you can predict the future, we would tend to advise against a market timing strategy. If, on the other hand, you invest long-term in a broadly diversified portfolio, you can profit from the short-term irrationality of the market and the resulting fluctuating stock prices. For this reason, our approach is to be broadly diversified across multiple markets with a long-term focus and regular investments. You can take advantage of market fluctuations by investing your money over a long period. The key to success in the world of investing is a savings plan that allows for a smooth averaging effect (“cost-average effect“). The logic behind this is simple. If you invest regular amounts in the stock market (for example, 100 euros per month), you will receive the average price of the selected shares. This way, you smooth out fluctuations and benefit from the success of your investment in the long term.