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What Moves the Stock Market?

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  • What Moves the Stock Market?

    You don't need an MBA to get a handle on the stock market. Unless your instructor has plenty of "hands on" experience with stock investing, the class room is not the best place to learn stock market basics.

    It's important to gain "market sense", and this is best accomplished by studying the stock market itself. How can the Dow Jones Industrial Average (DJIA or the DOW) be up 300 points one week and down 500 the next? What causes stock prices to fall 50% in less than two years?

    The law of supply and demand explains stock market basics and stock prices, if you want to get academic. What keeps stock investing interesting is that in the real world it's not so simple. View the stock market as a very large collection of people, each person with a profit motive. As a group they determine stock prices and move the market as they bid prices either up or down. Stock investing is a people game, not an analytic exercise. Market players are emotional beings, and do not always make rational decisions.

    You do not need to be a great stock picker to win at the stock investing game, but you should have a feel for the markets. In a rising stock market, a significant majority of stocks participate and go up. In a bear market like 2008-2009, few buck the downward trend. To get a firm grasp of what moves markets, let's look at recent market action that took the DOW down 50% between late 2007 and mid-March of 2009.

    Instead of thinking in terms of supply and demand, think fear and greed. Stock prices move down when investors (on balance) increase the supply of stock by offering shares for sale, sometimes motivated by fear. When greed kicks in they scramble to buy stocks, increasing demand and sending stock prices higher.

    By late 2007 the stock market as measured by the DOW had been up five consecutive years. All that was necessary for a change of investor sentiment was bad news. By late 2008 fear was rampant as financial crisis gripped Wall Street and the nation. The financial news went from bad to incredulous. Stock prices fell like a rock as fearful investors swamped the market with "sell" orders.

    A market does not fall 50% without a "fake-out" or two along the way. Here's where it pays to understand stock market basics and market dynamics. For example, after a three month drop of 2000 points on the DOW, a 1000 point rally would not be unusual. Such action is often caused by a spark of unexpected good news, and investor greed takes over as "buy" orders flood the market. In other words, who wants to miss out on the action?

    Rallies in a bear market hype the emotions, fear vs. greed. The perennial investor question is "how long will this rally last"? An upward move in stock prices can mark the beginning of a new bull market where stock prices go up for years. On the other hand, such a move could be a bear trap as fear once again takes over sending stocks to new lows.

    View stock investing as a people game. Understand that people move markets, and they are sometimes acting out of emotion. If you can keep a cool head while those around you panic, you're a step ahead in the stock investing game.

    A retired financial planner, James Leitz has an MBA (finance) and 35 years of investing experience. For 20 years he advised individual investors, working directly with them helping them to reach their financial goals.

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  • #2
    Great article