Why prices move
A price moves when investors' expectations change. News everyone expected hardly moves it. It's the surprises that do.
Learning objective: After this lesson you can explain why prices move and why unexpected news has a stronger effect than expected news.
At every price there are people who want to buy and people who want to sell. The price moves to where the two sides currently meet.
Who Is on the Other Side
In every trade there's someone on each side. If you buy a share because you think it's cheap, it's sold to you by someone who believes the opposite. One of you is wrong.
Why News Works Differently
That's why news often works differently than you'd think. A company reports record profits and the price falls. That sounds crazy, but it isn't. Investors had expected even higher profits, and that expectation was already in the price.
Remember: prices react to surprises. If you read something in the newspaper, everyone else knows it too, and the price adjusted long ago.
In theory the price is the point where demand and supply meet. Both come from the different expectations of all investors. For the price to change, at least one side has to shift. Investors have to expect something different, want to take more or less risk, or suddenly need money.
Efficient Markets
The theory of efficient markets says all available information is already in prices. In its middle form that applies to everything publicly known. Prices then only react to the part of an announcement that's new. You can see this clearly. After quarterly results the price jumps within seconds, and how far it jumps depends on how much the figures differ from analysts' estimates. How good the figures are on their own plays a smaller role.
Criticism of the Theory
The theory isn't undisputed. Behavioral researchers have shown that markets sometimes over or underreact, that trends last longer than they should and that bubbles exist. For you as a private investor that changes little. Even a market that's only roughly efficient reacts faster than you can open the newspaper.
Summary
- In every trade, someone on the other side believes the opposite.
- Prices react to surprises.
- What you've read is already in the price.
Did you get it?
Why can a price fall on good news?
Because investors had expected even better news. That expectation was already in the price.
What does the middle form of market efficiency say?
That all publicly known information is already in prices.
What follows for you?
That news anyone can read gives you no edge.
Check your understanding
Your task
Find a company announcement from recent weeks after which a stock moved differently than you expected. Write two sentences: what investors probably expected beforehand, and what was actually new in the announcement.
Sources and further reading
- Eugene Fama's foundational paper on market efficiency, defining the semi-strong form: all publicly available information is already assumed to be reflected in the price. View source ↗
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- Risk and return are linkedStage 1
- What a stock exchange isStage 1
- Gold and precious metalsStage 1
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