The law of supply and demand is probably a term you have heard of but not sure how it works. In this post, I’ll be breaking down the supply and demand economic model to identify how it applies to the stock price.
Disclaimer: None of what I’m talking about should be considered as financial advice. It is for entertainment and educational purpose only.
Relationship Between Price, Supply, and Demand
The price is derived from the amount of supply and the demand for a certain item. In this case, it would be the price of a stock. The intersection between supply and demand is the equilibrium point. Where the equilibrium point is at is what will determine the price.
There are various factors that can shift the supply and/or the demand. With each change, it can impact the price positively or negatively.
For example, if the supply decreases then the price would increase. On the other hand, if the supply increases then the price decreases.
Another example is the demand can increase and that would cause the price to increase.
These are fairly simple examples but it gets the relationship between supply, demand, and price across. In the real world, it would be more complex with the supply and demand constantly shifting.
Supply Factors in Market
There are various factors that can affect the supply of stock in the market. Some factors that are biased to the upside are:
- Active circulating shares are bought up and held, which reduces the supply available
- A company performs a stock split which increases the supply of overall shares while maintaining the same market capitalization. While the market cap is the same the reason to do a stock split is to make a share more affordable because the price is too high. This means the price is going up and a stock split helps by maintaining or increasing the demand.
Some factors that are biased to the downside are:
- The overall supply of stock can increase by the company offering more shares in the market.
- There can be an increase in active shares when locked shares are allowed to enter the market. Although the overall supply didn’t increase the number of shares available to be bought or sold increased.
- A company can choose to perform a reverse stock split which cuts the supply of overall shares while maintaining the same market capitalization. While the market capitalization doesn’t change the reason to reverse split is that the price is dropping too low. This helps bring up the price of a share temporarily.
Demand Factors in Market
There are various factors that can affect the demand side of the stock of a company. Some factors that are biased to the upside are:
- The company is doing well
- The price is going up
- Positive sentiment from investors
- Positive sentiment in the markets
- Low-interest rate environment
- Short squeeze
Some factors that are biased to the downside are:
- The company is doing more worst
- The price is going down
- Negative sentiment from investors
- Negative sentiment in the markets
- High-interest rate environment
- Liquidation or margin calls
At the end of the day, the market is a complex mechanism. With supply and demand constantly in flux, it causes the stock price to change rapidly. There are no deterministic ways to know the stock price. Understanding supply and demand factors are just another tool to help increase your probability of being on the right side.
I hope this post was helpful to you. If you found this post helpful, share it with others so they can benefit too.
If you’re new to investing and need a guideline to help you start your investment journey you can check out my post on setting yourself up for financial success. I also have a post about beginner mistakes to avoid in the stock market.
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