It’s actually quite straightforward: as in every marketplace, prices rise when there are more buyers than sellers for a share. And vice versa, of course. This means that supply and demand determine the price. The more extreme the ups and downs, the greater the “volatility”. Volatility provides information on the fluctuation range of a particular security. In other words: it expresses the intensity of the price fluctuation for a particular security and therefore to a certain extent the risk attached to that security.
Why do prices fluctuate?
Every investor is aware that prices rise and fall. But why does this happen? What causes these fluctuations?
Expectations from a company
In order to explain price fluctuations, another question has to be answered: why would anybody buy or sell a certain share? But the answer to this is slightly more complex.
The prices reflect investors’ expectations for a company’s value and future profits. If investors expect a company to perform well in the future, a greater number of people will want to purchase share certificates and the value of the company and each individual share will increase. And the same applies in reverse: if investors expect difficult times for a company, they’ll want to get rid of their shares. This will cause the price of the securities to fall. In other words: if expectations change, prices will rise or fall.
The role of the global economy
Some higher-level factors also come into play. The outlook for the entire industry in which a company operates will have an impact on price performance, for example. The general economic environment, economic forecasts and unemployment rates can also influence prices. In addition, there are numerous indirect factors that will influence investors’ behaviour, such as the interest rate environment and current returns from other investments. If interest rates are relatively low, a greater number of investors will invest their funds in shares, thus causing share prices to rise. Or the other way round. To a certain extent, it is possible to glean uncertainty in the market from volatility.
However, it also quickly becomes clear that prices never fluctuate for purely rational reasons. Investors should always remember that there are numerous psychological factors which can influence prices. After all, estimating future returns isn’t easy. In addition, many investors don’t find it easy to swim against the tide, which is why many of them do the same thing and go with the flow, even if there’s no rational explanation for it. Purposefully circulated rumours or deliberate speculation by professional investors can also influence prices, as can factors such as general anxiety caused by the global political landscape, regardless of actual facts and figures about companies and industries.