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News - 4 October 2011

Why does the Stock Market Fluctuate? Part Two.

People have wondered about and attempted to analyse the factors that drive the stock market since trading first began at the London Stock Exchange more than 300 years ago.

In part one of this exploration, we looked at the impact of Supply and Demand, The Economy and Interest Rates.

In part two, we see what influence Institutional Investors, Programme Trading, Psychological Issues, and the effect of Commodity prices has on the Stock market.

Institutional Investors.

Individual retail investors buy and sell stocks, as do large institutions, such as brokerage firms and mutual funds. But the difference is they don't purchase or sell securities in small quantities, but they instead tend to move large blocks and trade in bulk. The large volumes that these institutions trade can have an effect on daily, weekly and even monthly trading activity and price action.

If, for example, a large trading house purchases 500,000 shares of a particular FTSE 100 stock over a period of two trading days, then the price of the shares could increase rapidly as the supply of stock available for sale is soaked up. Or, conversely, if they sold the same amount very quickly, the price would drop dramatically; fears and rumours would be rife.

Programme Trading.

Large institutions will sometimes use computers and computer programs to help manage portfolio risk and execute orders. The good news is that they can be used successfully, if managed and protected well by their operators. The bad news, however, is that these programs can be used to fire off mass orders to buy or sell an individual security or group of securities in a short period of time, and this can have a huge impact on trading. This can be readily seen during the summer holiday period or the “silly season.”

Psychological Issues.

Psychological issues can have a tremendous effect on the markets. They can lead to both irrational exuberance and stock market bubbles, or sell-offs and short-term corrections in equity prices.

If individuals and institutions are bearish about the future, they may sell some of their stock holdings. This can create a self-fulfilling prophecy - in the markets, wide-scale pessimism can drive down stock prices and reduce trading significantly. But on a more positive note, the opposite could happen if the traders are upbeat about the prospects for the economy.

The Effect of Commodity Prices.

Commodity Prices can have a positive or negative impact on the equity markets as well. The one thing we are all aware of at the moment is the  price of oil: when it goes up, the price of fuel and petrol goes up, which means that fewer potential consumers will be on the road or shopping. Also, companies that ship their goods via truck or freighter will have to pay more for deliveries, which in turn may have an adverse impact on their profit margins.

Commodities such as cotton, wheat, rice, gas, metal, all of these and more can all have a significant effect on the stock market.

Thus, in this short and simplified explanation, the Bottom Line is that Investors should be aware of these factors before getting into the market, and certainly monitor them after they've made an investment.

If you need any help and advice on Inheritance tax, capital gains Tax, or any other implications with Stocks and Shares, don’t hesitate to contact Lavinia Newman, Stuart Coleman or Tonmoy Kumar to discuss how ABDS can help in all your financial planning.

ABDS Chartered Certified Accountants of Southampton.
Tel: 023 8083 6900  E-mail: abds@netaccountants.net

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