How Stock Market Trends Work

What Causes Change in the Stock Market?

Federal Reserve Chairman Ben Bernanke ponders the state of the U.S. economy.
Federal Reserve Chairman Ben Bernanke ponders the state of the U.S. economy.

So just what makes those ticker numbers change?

  • Inflation: Inflation is a rise in prices across the board. Inflation causes your dollar to be worth less. Inflation is the reason a car costs $7,000 in 1981 and $17,000 in 2001. Over the long term, inflation is good, because it means consumers are spending a lot of money -- the economy is robust. When inflation is too high, though, consumers pull back and spend less. After all, $5 is a lot of money to spend on a candy bar. When consumers spend less, companies don't make as much money. When companies don't make money, investors lose confidence in those companies. Many investors sell their stock because they believe the stock is worth less and is only going to decrease in price. As the demand for the stock decreases, the price of the stock decreases. When this happens to many companies in the stock market, the stock market experiences a downward shift.
  • Interest Rates: To bring inflation under control, the Federal Reserve System can raise the federal funds interest rate, which is the interest rate banks pay on loans they take from the Federal Reserve. Think of the Federal Reserve as a credit card for banks. When banks have to pay a higher interest rate, they often raise their own interest rates on loans and credit card accounts for businesses and individuals. This means that businesses and consumers must pay higher interest on borrowed funds. This usually causes consumers to spend less and businesses to borrow less. When businesses don't borrow money to develop that new widget, they tend to grow at a slower rate. When consumers don't buy things and businesses don't grow, companies' profits decrease, causing a stock price decrease. Conversely, when the Federal Reserve cuts the interest rate, investors tend to get excited. The cut means banks will be borrowing and lending more and at better rates. Businesses will grow and consumers will spend. Company profits will go up. Investors tend to buy, buy, buy!
  • Earnings: When Widget Co. reports profits, everyone wants a piece. Profit means the company is doing well. But maybe after a while, people grow tired of widgets and want to buy the new whatsit instead. Widget Co. reports lower profits. As you saw with inflation and interest rates, when a company reports lower profits, investors lose confidence in the company and sell their stock, which decreases the value of the stock.
  • Energy Prices: People always need energy. Electricity and natural gas keep us warm, cook our food and keep our computers happy. Therefore, the demand for energy is pretty constant. Only major changes in energy costs have a significant effect on the stock market.
  • Oil Prices: People almost always need oil, in the form of gasoline. When gas prices are high, however, some people look to alternative methods of transportation -- carpools, public transportation, bikes, etc. Others keep paying the high price but, as a result, buy fewer consumer goods. The stock market tends to react negatively to high oil prices.
  • International and Domestic Issues: War tends to affect the stock market negatively. The same goes for crime, fraud, and domestic or political unrest. Consumers worry when CEOs steal money, terrorists kill innocent people, or politicians are involved in serious scandals. Who knows what will happen next? Consumers save their money. Businesses make less money. Investors tend to dump their stocks, causing a fall in the market.
  • Fear: Besides being afraid of the market consequences of war, oil prices or a federal interest rate hike, investors are afraid of losing their money. Investors tend to dislike seeing their money dwindle as the price of their shares decreases.

All these factors cause changes in the market. But what about the long-term trends? Learn about bull and bear markets next.