How Stock Market Prices Are Determined

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Stock market prices fluctuate frequently over the course of a day. This is supposed to reflect changes in the demand for a stock or changes in expectations about a company’s profitability. However, the mechanisms by which stock prices are determined seem hazy at best. Despite the lack of clear information, traders continue to guess and send prices soaring.

There are several theories about why prices fluctuate. One of the most widely accepted theories is the theory of random walks. In this theory, every publicly available piece of information about a security is embedded in the market price. This makes it impossible for analysts to identify mispriced securities. But the theory does not explain the phenomenon completely.

To explain why a stock’s price fluctuates, we must first understand how these prices are determined. Dividends and prices of stocks are affected by earnings and interest rates. A rising interest rate lowers the dividends of a company, while a falling interest rate increases the dividends. Both are linked to the overall economy.

If a country experiences a recession, its stock market prices are likely to fall. In the United States, 39 of 42 recessions in the past two centuries were preceded by at least 10% declines in the stock market. The decline in the stock market has been particularly harsh on people who are paying for college or retirement.

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