The Only Two Things that Move Stock Prices

Despite what people may otherwise tell you or any preconceived ideas you may have, there are only two things that move stock prices. They are supply and demand – nothing more and nothing less. This is the foundation of basic economics as shown in the graph below. Since quantity remains the same, price is what fluctuates as a results of supply and demand.

If there is more demand than supply for a stock, then the price shall rise. Conversely, if there is more supply than demand for something, then the price shall fall. This is absolutely true in any market.

The next question is what affects the supply and demand for a particular security or traded instrument. Is it the profits in the financial statements? The upcoming expansion plans? The new product? Is it dividend payments? No one can be absolutely sure at any point why people may be buying and selling shares. That’s where technical analysis comes into play.

The Only Two Things that Move Stock Prices

The Only Two Things that Move Stock Prices

At no time does technical analysis attempt to determine why there might be supply and demand, only that there are certain levels of supply and demand. By studying actual movements in the price and volume, we can go a long way to determining what the present demand and supply is and therefore predicting the future direction price will take.

All fundamental and economic influences on a share price are already taken into consideration in the market, which is reflected in the price. As a trader, what you are buying and selling is the actual price, not financial statements or ratios like the P/E ratio or ROE figures. Ultimately, it is the price that ultimately determines whether you make money or not, and what you think the price should be has NO influence whatsoever on the price.

The next big revelation is that the bulk of supply and demand does not come from retail traders or retail investors. They come from the big boys (BB) and smart money (SM) like traders and fund managers in banks, funds and other institutions. They are the ones who move the market. Learning to interpret price action and volume is our window to tap into their psyche and profit from their actions.

EUR/SGD – going down, down, down…


The Euro is going down, and is showing extremely weak technicals, which underlie the festering Greece debt fundamental problems. This is the first test of the 20-EMA after staying away for quite a long time, showing the bearish pressure. It also coincides with a breakout below the support of 1.92 and a pullback. On an unrelated note, it seems that my holiday here in Europe is getting cheaper and cheaper. I will be timing my exchange of SGD to EUR near the support levels.

S&P 500 – new highs after breaking out of inverted H&S | Technical Analysis | Stock Indices

After completing an inverted H&S, the S&P 500 has proceeded to make new highs. Judging by the numerous strong white bars, the upward pressure is quite strong. It might be a good idea to go long on a pullback, perhaps on a test of the breakout to new highs. On a side note, I will be heading to Budapest this weekend. 

Dow Jones – familiar pattern could propel Dow to over 12,000 | Technical Analysis | Stock Indices


A similar-looking pattern suggests a lot of upside, especially if it finds support at the W-pivot and both EMAs. Please ignore the volume, it’s not working right for this index. Based on the length of this pattern, we could be seeing upside moves of beyond 12,000. Be ready to start buying!

The Random Walk Myth: Theory vs. Practice

The random walk theory, which started off from academic offshoots, put forth the idea that one should give up trying to predict or beat the markets because it was impossible to do so. In theory, this theory sounds plausible, but in practice, financial history has proven otherwise, with both investors and traders consistently beating the markets.

 

The Random Walk Myth: Theory vs. Practice

The Random Walk Myth: Theory vs. Practice

 

The random walk  theory states that price history is not a reliable indicator of future price direction because price changes are “serially independent”. In other words, there is no definable relationship between the direction of price movement from one day to the next. This does not mean that prices meander aimlessly or irrationally, but it means that prices have no patterns of order within the chaos.

We know that prices are determined by a balance between supply and demand. Random walk theory asserts that prices reach that equilibrium level in an unpredictable manner, moving in an irregular response to the latest information or news release. New information, being unpredictable in content, timing and importance, is therefore random in nature. Consequently, the theory puts forth that price changes themselves are random.

Try this interesting optical illusion:

The Random Walk Myth - Can you see the pattern here amid the "randomness"?

The Random Walk Myth – Can you see the pattern here amid the “randomness”?

While price changes might seem random in nature, the trend of prices themselves are not. In reality, price movements contain well-known components of trend, seasonality and cycles which are not random in nature. Although these are mostly clear when prices are considered over the long-term, if one observes prices very closely in the short-run, price trends or patterns are also readily recognisable.

Technical analysis and chart-reading analyses the impact and action of market participants in response to the latest news or information. As a result, it is possible to understand what the different market participants are doing, and which way the market is likely to trend next. Besides, the market is not perfectly efficient, and reading the actions of the smart money will often alert traders to what is happening in the markets.

 

“The illusion of randomness gradually disappears as the skill in chart reading improves.” – John Murphy