When you invest in financial products like stocks, bonds, and investment funds, a way to make a profit is through capital appreciation. This is when you buy an asset low and sell it at a higher price.
Conversely, you can end up losing money when you buy high and sell low. But what makes prices go up and down? Is this something you can possibly predict to avoid losses?
In this article, we’ll look at the factors that can affect the value of investments.
Understanding the law of supply and demand
The law of supply and demand is the main reason prices change. Simply put, when more people want to buy an investment than sell it, the price goes up. When more people want to sell than buy, the price goes down.
For example, if a stock is in high demand, sellers tend to raise the price since more people are willing to pay a premium. If fewer people want it, sellers may lower the price to attract buyers.
In turn, there are various factors that influence demand for investments.
Factors that affect demand for investments
Investors are more likely to buy an asset if they’re confident about its potential to grow and make them money. When confidence is low, people are more inclined to sell.
The overall confidence and attitude of investors – also known as market sentiment – can be swayed by developments in the economy and within certain industries and companies. Here are some examples:
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Economic health
Generally, when an economy is growing, more people have jobs and so more people are confident to spend more.
Increased consumer spending, investor confidence, and economic activity means businesses and investment markets tend to do well.
As companies report good earnings, their stocks can become more attractive. During these times, people typically have more disposable income to invest with, and they may be more open to taking risks.
Higher-risk assets like stocks may see increased demand when an economy is booming.
On the flip side, when there are signs of economic trouble, people may prefer to keep their money safe by investing in lower-risk assets, like bonds and deposit products.
An economy can go through phases of growth and decline. Demand for different types of investments may change throughout each phase.
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Changes in interest rates
Central banks like the Bangko Sentral ng Pilipinas (BSP) set policy interest rates to help the economy grow while keeping inflation in check. Changes in interest rates can affect how investments perform.
Higher rates make borrowing more expensive for both businesses and consumers. This can curb spending and possibly slow the growth of companies, which may lessen the appeal of their shares and lead to lower prices.
Interest-bearing assets like bonds, on the other hand, can become more attractive when rates are high.
The opposite may happen when rates are lowered to stimulate economic activity. Rate cuts may renew investor interest in stocks and make new bonds less profitable.
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Company or industry performance
A company’s fundamentals, which include its financial performance and growth prospects, are among the things that guide investors’ decisions on whether to buy or sell its shares.
Financial health also matters for debt securities like bonds, since the issuer’s credit rating can affect a bond’s attractiveness.
Sometimes, the financial outlook or health of an influential company can affect its peers and the wider industry. For example, when good news boosts interest in a big technology company, the entire sector may see higher demand.
There are also industry- or sector-wide events that can have a widespread impact, like technological developments or the announcement of new regulations.
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Unexpected events
Unpredictable events like major disasters and geopolitical conflict can shake investor confidence. When there’s heightened uncertainty, people may want to protect their money via “safe haven” assets that may remain stable or even grow during hard times.
Sometimes, prices move just because of news or rumors that made people feel optimistic or fearful, even if there has been no major change yet.
Things to remember
- Supply and demand are the primary forces driving the prices of investments. However, there are various factors that can affect the availability of, and demand for, different types of investment vehicles.
- Prices can change more frequently for some investments than others. This is called volatility, and it determines an asset’s risk suitability.
- Investor sentiment isn’t always rational or predictable. Since investors can act based on how they feel, short-term price changes may not always reflect an investment’s long-term value.
- There are other ways you might earn from investing aside from buying low and selling high. Some investments pay interest and dividends.
No one can predict price movements perfectly. Knowing the basic forces behind the changes can help you stay prepared for what might happen next, while you understand that ups and downs are a normal part of investing.
