The prices of financial instruments change for various reasons. Some people believe that it’s impossible to forecast the changes, while others think that looking past movements, charts and formulas could determine when the perfect moments for buying and selling are. The market is volatile, meaning prices can rapidly change.
Historically and generally known, demand and supply are the most important factors that influence the price of an instrument.
The earnings and performance generated by any instrument might affect how investors give value to companies, but other indicators have the role of predicting the price.
Nowadays, perfectly in sync with the technological evolution, power of social media and personal connections, instrument prices are also greatly affected by investors’ sentiments, expectations, and personalities.
Finding connections between financial instruments
The marketplace sets up instrument price, and while buyer demand and seller supply do meet and exchange influences in the market, there is no universal equation that can predict the future of prices for investors, there are a few factors that can be taken into consideration when researching an instrument or an asset class.
Understanding data reports, liquidity and market movement
You might’ve heard the term “market correlations” used at some point in your trading journey. Simply put, these are ways of measuring the connections created between different markets or financial instrument classes.
Correlations can either be positive or negative, and their strength can also change over time, depending on the events that occur and the way they unfold.
Aside from markets reacting to external events, these also react to each other. So, for example, if a Central Bank would increase the interest rates, this might lead to 2 potential scenarios:
1) Increase the specific country currency value
2) Decrease the value of the specific country currency
Different types of instruments depend on different factors, but generally, the marketplace is affected by common occurrences. Among the most important factors we can spot:
Forecasts and expectations of future corporate earnings
In simpler words, a company’s current share price reflects investor expectations of its future stream of earnings.
Interest rates are the rates that the bank pays you back on interest. In the case of low-interest rates, the demand for actual funds is higher and thus the buying of instruments might increase. Switch up the variables, and you’ll find that high-interest rates lower the fund demand and also directly affect the asset demand by lowering it.
As inflation reduces purchasing power, the greater the risk of inflation, the more investors will be tempted to sell their bonds which return a fixed rate of interest and transform that into stocks or other assets that generally outpace inflation.
Economic growth & expansion
Fluctuations that happen in the economic system pave the way for booms and depressions, periods of favorable or unfavorable conditions, which make prices reach their peak or their lowest points.
Political environment & tensions
Generally, the government plays a big role in guiding the direction of the economy, stock prices usually anticipate and react to the changes.
Supply & demand effect
Other types of instruments, like commodities, are usually affected by storage costs, the perishable rate of products, seasonal factors such as harvests and yearly weather conditions which directly influence the storage costs and supply sides.
On the other hand, other instruments are simply affected by a constantly changing supply and demand, as market investors try to benefit from supplies drying up or others are forced to buy at higher prices, creating huge price increases.
An essential and seldom under-appreciated factor, referring to how much attention a specific instrument attracts. The highly liquid ones will be more responsive to material news.
Material news is the company’s price-sensitive information announced publicly. Large-cap stocks and companies usually benefit from high liquidity as they are well followed and largely transacted.
On the downside, small-cap stocks are simply not on investor radars and boast an almost permanent “liquidity discount”.
Short-term trends provide momentum, and since success gives birth to more success, popularity propels stocks higher, or on the other hand, makes it behave the opposite way, reverting its direction. Regardless, when dealing with an instrument that is trendy, it’s important to see the bigger perspective and not just the direction of the trend.
Bold research has been done about the demographics of investors, with the new generations now rising and claiming a good part of the stock market.
Simply put, market players have an impact on instrument prices. This category mainly refers to the psychology of investors actively participating in the financial markets, both individually and collectively. As it’s generated by actual people, the sentiment is often subjective and biased, missing an objective analysis and relying or moving based on artificial news or feelings.
Perhaps the most volatile out of all the factors, market sentiment relies on one’s judgments and can even be considered a social science, as it’s been noticed throughout the time that investors tend to over evaluate data that pop easily into their mind.
On the other hand, others react with greater pain to losses than with happiness to the equivalent gains, all of this topped by the behavior that leads them to persist in a mistake rather than stepping aside.
Applying theory to your strategy
Walking loaded with theory in the financial markets is an easy task for most individuals, but actually transforming that into useful insights that can build up and enhance your strategies is a tough journey for most individuals, if you don’t have a valid starting point or cannot put together a bigger picture.
If anything, all the information mentioned above serves as a reminder of the complex nature of the financial market. It always pays off to take into consideration fundamental and technical analysis, market sentiment and perhaps even indicators and formulas.
The most important conclusion is not taking correlations and instrument links for granted, as they aren’t a sure-fire thing, especially in the unpredictable era that we find ourselves in today.
As you’re advancing through the stock market and creating your own research, it’s important to understand the many wheels and bolts that sustain such a big factory, the marketplace.
It’s important to take into account that over time, economic circumstances change and can alter existing market links. To be able to adapt to any incoming market transition, tune into the fundamentals of trading and understand why correlations actually exist.
This will help you become more aware of any causes or possible changes to the existing instrument relations.
Found this article interesting? Stay tuned for a more detailed overview, based on what affects each instrument that makes up the marketplace – only on capex.com!
The information presented herein does not constitute and does not intend to constitute Investment Advice. The information contained herewith is a compilation of public stock recommendations issued by various financial analysts and organized in an easily presentable format, for information purposes only. Key Way Investments Ltd does not influence nor has any input in formulating the information contained herein. The content herewith is generic and does not take into consideration individual personal circumstances, investment experience, or current financial situation. Users/readers should not rely solely on the information presented herewith and should do their research/analysis by also reading the actual underlying research. Users/readers should also consider the risk of encountering significant losses when trading CFDs. Therefore, Key Way Investments Ltd shall not accept any responsibility for any losses of traders due to the use and the content of the information presented herein. Past performance is not a reliable indicator of future results.