The stock market rises and falls all the time and riding the waves of the market can be uncomfortable and confusing, especially for first-time investors. So we’re breaking it all down, including what affects stock market performance and why you should stay cool when markets fluctuate.
What causes the stock market to go up and down?
Stock markets go up and down as investor confidence rises and falls. If confidence in whether companies can generate a return on investment is high, investors might buy more shares – which can push share prices higher. But, if investors aren’t confident in a potential return, they might start to sell their shares – which could drive prices down.
You might sometimes hear a couple of technical phrases when the stock market is fluctuating. People say ‘bull market’ 🐂 when the market goes up, and ‘bear market’ 🐻 if the market falls. The names come from the way these animals attack – a bull swipes up with its horns, but a bear swipes down with its claws.
The factors that we’ve listed below all affect investor confidence and so will play a role in stock market performance.
Supply and demand 💷
Supply and demand are two of the most important influences on whether share prices rise or fall. When supply is high but demand is low, prices are likely to decline, but when supply is low and demand is high, prices will probably increase.
The political party that’s in government can affect the stock market’s performance because different policies could change how companies are allowed to operate.
For example, markets often react favourably to governments that are more pro-business and in favour of fewer regulations – while they might fall when governments introduce new regulations that could affect businesses’ performance.
Economic factors 💰
Economic factors like interest rates, taxes and inflation can all affect stock market performance. These all feed into supply and demand. For example, if a government chooses to cut taxes, people may have more money to spend. If this is coupled with reduced interest rates, there could be less of an incentive to save that money in a low-interest bank account.
Instead, people may look to invest it in the stock market – which has historically beaten the returns of cash savings and protected against inflation over the long term (more than five years). If this happens, demand for stocks could increase and you might see the stock market rise.
Index weightings ⚖️
Index weightings are how stock market indices are calculated. Different weighting methods will determine which companies have a larger influence over the index’s value, and so index weightings have a large impact on making stock markets rise or fall. Here are the main two types of stock market index weighting:
- Capitalisation-weighted indices (like the Nasdaq 100 in the US) place greater weighting on companies with larger market capitalisations – meaning that the performance of larger companies will have a greater impact on the index’s value. So, if Apple, Alphabet and Microsoft are all having a bad week, it’s likely that the Nasdaq 100 index could fall.
- Price-weighted indices (like the Dow Jones Industrial Average in the US) give greater influence to the companies with the highest share prices. This means that companies that might not necessarily be the largest can still influence the performance of the index.
Company announcements 📅
If a company is publicly listed, then announcements – whether at the end of a financial quarter or the end of a financial year – will often have an impact on the stock market. Many publicly listed companies release their financial performance around the same time throughout the year.
There are usually announcements at the end of each financial quarter, so you might see more stock market movement around January, April, July, and October as companies release their quarterly earnings.
Stock market corrections and crashes
One of the most important things to remember when you’re investing is that the stock market will fall from time to time. There are two classifications to be aware of here – corrections and crashes:
- Stock market corrections represent a 10-20% decline in the value of the stock market and they are often shorter in duration than crashes – with quicker recoveries to pre-crash levels.
- Stock market crashes are more severe, and they represent a fall of more than 20% in the value of the stock market. They are less common than corrections, but they do happen – and the market might take a little longer to recover.
The graph below shows some of the FTSE 100’s biggest stock market crashes between 1984 and 2021 – as well as the post-crash recoveries.
While we can’t predict the future, so far 100% of crashes have been followed by a recovery that more than made up for the fall – but remember that past performance isn’t a guarantee of future results.
What to do in a stock market crash
During a stock market crash, it’s important to remember your secret weapon – time. 🕰️ Warren Buffett, the world’s most successful investor once said “the only value of stock forecasters is to make fortune-tellers look good”. He meant that it’s almost impossible to know exactly what the market is going to do tomorrow.
So, it’s spending time in the market, not attempting to time the market (i.e. trying to sell just before prices go down and buy back in just before they rise) that’s the key to success. The longer you leave your money invested, the more time it has to grow and benefit from the magic of compounding (we talk about compound interest in Lesson 7).
For example, the FTSE All-World GBP averaged an annual return of 9.69% between 2014 and 2021, compared to a return of just 3.18% from 2014 to 2016.* By spending more time in the market, the gains increased!
If you tried to ‘time the market’ you could have also missed the best trading days. Even though your instincts would tell you otherwise, getting out of the market when it’s falling can be the costliest mistake of all. A JP Morgan study from 2019 found that 6 of the 10 best days in the market (based on the S&P 500 index) over a 20-year period occurred within 2 weeks of the 10 worst days.
If you understand that corrections and crashes are going to happen, then you’re better prepared and know what to expect. Despite the fact that crashes occur, historically the stock market has been one of the best places for people to grow their money over the long term. But remember, you need to understand the risks, not invest money you need in the short-term, have a long-term mindset, and keep your emotions in check.
Ready to start investing for the long term? Check out investing with Moneybox.
Question one: Which of these indicates that a market is falling in value?
- Bear market
- Bull market
Question two: When supply is higher than demand, what might happen to a company’s share price?
- It might fall
- It might rise
Question three: Finish this sentence: stock market corrections represent a fall of…
Quiz answers are below!
🎓 In the next lesson we’ll look at asset classes, including what they are and why they’re important.
Question one: Bear market
Question two: It might fall
Question three: 10-20%
* FTSE All-World GBP historical data, retrieved 5 August 2021
All investing should be regarded as long term (minimum five years) and historic performance isn’t a guarantee of future returns. The value of your investments can go up and down, and you may get back less than you invest. We don’t provide investing advice, and investors should make their own investment decisions or contact an independent adviser.