Having a solid understanding of the stock market can often feel out of reach. Sometimes it follows a predictable pattern and seems to make sense, while other times it’s volatile for no apparent reason.
Both are true!
Over the long term, the stock market will usually follow regular patterns, and in the short term, there’s more market volatility.
A lot of people simply look at the short term, though, and only see large market fluctuations, which is why they associate investing in stocks with risk.
This doesn’t have to be the case! When you understand what makes stocks go up and down, learn to control your own emotions when they do, and act using the Rule #1 principles, you can invest confidently, without worrying about what the market will do tomorrow.
So, what causes stock market fluctuations? And, perhaps more timely, why is the stock market going down?
There are many factors that affect the market and can cause a stock market crash or more minor market volatility. We’re going to dive into a few of those factors below and hone in on the one you should really be aware of… emotions.
How The Stock Market Works
Let’s first get into what the stock market is and how it works. Because once you understand how the stock market works, it will help you be a smarter, more successful investor.
The stock market is a vast network of economic transactions where buyers and sellers trade shares of public companies—which are stocks—with one another.
The price of a stock is determined by how many buyers vs. sellers there are of that stock at any given moment. This is basic supply and demand, which we’ll cover below.
But there are plenty of other factors that influence the supply and demand of a stock. These include events, which typically lead to stock market crashes, economic factors such as the rise or fall of interest rates, and investor expectations and emotions.
Let’s cover all of these in more detail…
What Causes Stocks to Go Up & Down
If you’re wondering, “Why is the stock market going down?” look at these key indicators. A few of these factors are to blame for why stocks are going down right now.
Supply & Demand
As I mentioned above, the price of a stock is influenced by how many buyers there are of that stock at any given time (the demand) vs how many sellers there are (the supply).
If a lot of people are selling and not that many people are buying, the price of the stock will drop.
If, on the other hand, there are a lot of people wanting to buy and not a lot of people willing to sell, the price of the stock will rise. At the most basic level, this is how stock prices change.
Future Expectations & Events
The stock market is always looking forward to what might happen in the future — it’s almost never looking at what’s currently happening.
We look at current and upcoming events to see how they will affect the companies we’re invested in or plan to invest in in the future. This helps investors determine whether to buy, hold, or sell.
This is why breaking news about a company can influence its stock price dramatically, or why we saw a significant drop in stock prices market-wide in March of 2020 when Covid-19 became a global crisis.
While the pandemic hadn’t yet impacted businesses, it was clear that it would have a significant impact in the coming months.
Other examples of events that make stocks go up and down are natural disasters, wars and other conflicts between nations, changes in trade policies, elections, etc.
Fluctuating Interest Rates
Rising interest rates and the expectation of rising interest rates may also be the answer to why the stock market is going down. When the Federal Reserve raises interest rates, banks tend to follow suit, which makes it more expensive to borrow money.
When it’s more expensive to borrow, everyone—both companies and consumers—tends to spend less. Less spending typically means less growth, and less growth can mean companies aren’t increasing their value to warrant higher stock prices.
The biggest factor that influences fluctuations in the stock market is the emotions of investors and the decisions those emotions drive them to make. The primary emotions that make stocks go up or down are fear and greed.
When investors are greedy, they tend to buy more, which drives the price of stocks up, up, and up. However, when investors are fearful, they sell, and sell quickly, which causes the price of stocks to drop.
It’s critical to understand how emotions influence the stock market so you can learn to keep your emotions out of it. Greed can show up subtly as excitement, a desire to stake a claim in the next big thing, or hope in a company to achieve great things. It can cause you to overlook red flags and invest when prices are too high.
Fear, on the other hand, can cause you to sell too soon, or to resist investing when the opportunity arises. There are ways to ensure that both fear and greed don’t impact your investments, but the first step is being aware that, for other investors, they often do.
Take Advantage of a Volatile Market with Rule #1 Strategies
Whether the stock market is going up or down isn’t actually the most important thing to understand. What’s more important is how you as an investor can take advantage of stock market fluctuations to grow your wealth—and you can!
Stocks going down isn’t always a bad thing. In fact, a stock market drop is what we Rule #1 investors wait patiently for to happen.
When others are selling because of fear, you can pick up wonderful companies at incredibly low prices.
This is possible if you learn how to not let your emotions impact your investments. Instead, you can use the 4 Ms and the Big 5 Numbers—these are metrics I use to evaluate whether companies are worthy of my investment and determine the right price to buy them at.
With this knowledge, you can confidently invest when prices are dropping and sell when prices are rising to gain incredible returns.
Start preparing today with my Market Crash Guide, and you’ll be ready to make some smart investments when the stock market is going down.
Phil Town is an investment advisor, hedge fund manager, 3x NY Times Best-Selling Author, ex-Grand Canyon river guide, and former Lieutenant in the US Army Special Forces. He and his wife, Melissa, share a passion for horses, polo, and eventing. Phil’s goal is to help you learn how to invest and achieve financial independence.