Managing Risk Linked to Investing
Overview
In this module we will consider some of the factors that influence the supply and demand of shares, and therefore the price of said shares.
Understanding and analyzing these factors can assist you as an investor in managing the risks linked to investing.
Supply and Demand
Share prices react to supply and demand. An increase in demand means an increase in price, unless supply increases to match it.
If an increase in demand is accompanied by a decrease in supply, the rate of price rise increases. In other words, if more people want to buy a share (demand) than sell it (supply), then the price moves up. Conversely, if more people wanted to sell a share than buy it, there would be greater supply than demand, and the price would fall.
The appeal of shares, and ultimately the price of shares, is impacted by supply and demand. Though it might seem like there are other factors at play, such as company earnings or the economy’s health, these are really just drivers of supply and demand.
In effect, the market determines what a share is worth regardless of whether you think it is over or undervalued. It’s all about the activity between buyers and sellers.
As an investor, it is important to analyze and understand the factors at play that drive supply and demand in order to manage the risk involved in investing. We will now explore some of these factors.
Economic Factors
Economic factors including inflation, the financial outlook and changes in interest rate all affect the prices of shares. If inflation and interest rates rise, and the economic outlook is poor, there will usually be a decrease in demand, which will likely result in the share price coming down.
The South African share market may also be effected by the health of other economies such as the US. For example: when bad economic news causes a fall in the US share market, the South African market may come under pressure the following day even though it’s US economic data, not South African, due to the strength and reach of the US economy.
It would prove useful as an investor to consistently monitor news about the economy both locally and globally.
Political News
A political development – within or outside the country – could impact the share price. This factor generally cuts across all the shares on the market. In other words, this is a factor that influences all the shares regardless of the sector classification. The political factor can be noticed through regulatory processes and it eventually influences (not specific) share prices.
Political factors, especially domestic ones, have swift and severe effects on share prices since politics or government determines policies that can benefit or hamper investments. Additionally, there is politics involved in tax decisions, investment promotion, and expansion of export markets.
News from Zimbabwe or other states can influence share prices. Legislation governing the rules under which companies operate, as well as the way they operate can influence share prices. The government may lower the rate of company tax and this may increase share prices because it means a lower tax burden and increased earnings.
Perception factors also contribute to the fluctuation of share prices. South Africa is classified as a developing country, and so the general perceptions that exist towards developing countries will also impact local share prices.
Investors can’t ignore political risk, which hinges on changes to legislation. Virtually every company has something to fear or to gain from the government and its regulatory agencies.
Industry Trends
The trends of an industry frequently define share prices because companies operating in the same industry are subject to the same pressures and often perform similarly.
As a result, when an industry is growing, the demand for shares in that particular sector will usually go up, which will then push share prices up. It is also likely that demand for one company’s shares can increase if a competitor is performing poorly.
Market Sentiments
Market sentiment refers to the psychology of market participants, individually and collectively. This is perhaps the most frustrating category because we know it seriously matters, but we are only starting to understand it.
Market sentiment is often subjective, biased, and fixed. For instance, you can make a strong judgment about the future growth prospects of a share, and the future may even substantiate your projections, but in the time being the market may just decide to dwell on a single piece of news that keeps the share unnaturally high or low. And you can occasionally wait for an extended period of time in the hope that other investors will note the fundamentals.
Company News
The share market is ravenous for information and the continuous disclosure requirement for companies ensures a constant flow of news about all aspects of company operations. Investors are also able to gain access to political, economic and scientific news.
Any news that affects company earnings also influences the share price – industrial companies win new contracts; biotechnology companies release the test results for their drugs. All this news has to be weighed and evaluated as to how it will affect the earnings and the return on your shares.
The profits of a company are also an issue in share investment. If a company is doing well in terms of its business activities it is likely to attract more investors, which will result in a higher demand of their shares. A company that is not performing well business-wise may result in investors selling their shares on the market. The selling of shares enmasse will lead to more shares flooding the market and therefore bringing the price down – a large quantity of a commodity leads to price decline.