Stock prices move up and down seemingly at random. In fact, it's not random at all, but reflects buying and selling activity during the trading day. It's the buying and selling activity that's seemingly random. I realize this seems like a useless distinction, kind of like when Douglas Adams's holistic detective Dirk Gently, by means of automatic writing, wrote down the answer to a mystery in a language he didn't know, thereby transforming an intractable detective problem into a merely linguistic one -- albeit an intractable one. But bear with me.
There is no "market price" for stock -- only the last price someone paid. When someone sells a stock, they obviously want to sell it to the person who has the highest standing offer to buy it. If they want to sell more shares than that person is willing to buy, then they have to move on to the next lowest bidder to sell the rest of it, driving the price down. If you really want to unload a lot of a stock, you have to keep offering it at lower and lower prices until it's gone. Similarly, when buying, bidders naturally start with the shares of the lowest-priced seller and move up, driving the price higher. It's nearly pure supply and demand.
Many real-world events can cause buying and selling activity. Recently, the Fed raised interest rates, and a lot of stocks showed a downward blip. This happens when people want out of the stock now and that's more important to them than the price they're getting (possibly they figure it's had a nice run-up already, so the exact price doesn't matter). If an analyst goes bullish on a stock (increases the stock's rating or projected earnings or target price), that can cause a rush of buying activity, and the reverse can happen if an analyst goes bearish. When a company is on the front page of the New York Times for corporate malfeasance, everyone wants to sell, nobody wants to buy at anywhere near the recent price, and the price plummets.
When a rising stock reaches an analyst's projection (or even a nice round number, like $100 a share), people who bought in at a lower price often start thinking it's gone as high as it'll go and begin selling ("profit-taking"), driving the price down. Some people will intend to sell at a given price but miss the boat the first time, or else be spooked by its precipitous decline, so they wait until it goes back up to sell off. And sometimes there are additional waves. Similarly, when a stock dips to a point that a lot of people consider it a good value (e.g. a Motley Fool newsletter suggest a given stock is a buy at $20), buying starts, driving the price up. If it dips back down to the recommended price after the initial buying frenzy subsides, some people will add to their position and/or try to get in on what they missed the first time, causing another spike, and so on.
If a stock stays near the same price for a while, it can develop a sort of cycle of buying and selling in which some investors get out of the stock because it's not making any big moves, driving it down a little, and other investors who have been waiting to get in at a good price snap up the shares, driving it right back up. This kind of activity is, to my understanding, what causes the behavior of stock prices that technical analysts refer to as "resistance" (the seeming unwillingness of a stock to go above a certain price) and "support" (the seeming unwillingness of a stock to go below a certain price).
Technical analysts believe they can determine support and resistance levels, as well as the stock's general up or down trend, from the stock chart itself, knowing nothing else about the company. In short, they believe stock prices are almost entirely psychology and that human nature is predictable enough in aggregate to predict using chart analysis. I'm not entirely sold on the concept myself, as obviously there are lots of stock moves caused by real events, but I sometimes check a technical analysis to see if a better entry or exit point is predicted to exist within a few days for a stock I'm considering buying or selling. Results thus far have been mixed, perhaps with a very slight positive bias, which is pretty much what I expected.
Posted by kindall at July 6, 2005 09:08 AM