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If there is a buyer for every sale, why does the stock market fall?

Amitabh Tiwari
·Columnist
·5-min read

By Amitabh Tiwari & K Shankar

If you are a regular investor in stock markets, or even a viewer of TV news, you must have come across these phrases:

  1. On the day the stock market or some stock falls, experts say: ‘The market or a stock is going down because there are ‘more sellers than buyers’.’

  2. On the day the stock market or some stock rises, experts say: ‘The market or a stock is going up because there are ‘more buyers than sellers’.’

In every single trade, there is exactly one buyer and exactly one seller.

To say that there are ‘more buyers than sellers’ (or vice versa), is not just meaningless, it is plain and simply wrong.

‘When the markets fall, often we hear that there are more sellers than buyers in the market. But that is not technically correct. Markets work on supply and demand in balance principle, so the thing which changes is the PRICE. So when the demand and the supply get balanced at a lower price, it means the market has fallen. And vice versa, if this balance is achieved at a higher price, the market has gone up,’ says Pankaj Sharma, ESG Specialist, COO at S-Ancial and Partner at EMAlpha.

To further elaborate on the point; the price of a product/commodity in a traded market provides :

  1. Value in rupees of the underlying asset.

  2. Provides an avenue to two people to exchange goods for money using a common denominator (rupees is the common denominator in India).

  3. Based on the previous trades and value, we get the perspective on the underlying demand for any asset. If the price is relatively higher, then there is more demand. Conversely, there is more supply or less demand, the price is relatively lower.

In economics, a price level at which supply and demand of a product or service match each other, is called the equilibrium price. So, if the demand increases, other things remaining constant, price will also increase and, correspondingly, if supply increases, the price will fall. The equilibrium price changes its level depending on the change in demand and supply situation.

In equity markets, too, shares of companies get traded on the same principles, but with a slight difference. A company’s share price reflects the sentiment surrounding its future potential.

The value of the company is represented by:

Market Capitalisation = Number of equity shares x prevailing share price.

Since a company does not often raise money via issuing new/fresh shares, rise in its share price denotes higher value and fall in the share price reflects value erosion.

In addition, since in the stock market where the shares are traded, consists of a different set of people, the perception of any development, news or a future prospect could be completely different. This would lead to completely contrary actions with the respect to trading of the respective company’s shares.

So, for the same development someone could be a buyer (as he/she is bullish) and based on the same development someone could be a seller (as he/she is bearish).

The following is a screenshot of top BUY quantities and corresponding price levels and top SELL quantities as well as price levels. The last traded price of Reliance Industries as on 1:20 pm on September 16, 2020 was Rs 2,341.90.

Trading Terminal Screenshot

In any trade, it is a normal practice for a seller to command a higher price (Rs 2,342.70 and more) and the buyer to seek a lower price (Rs 2,341.90 and lower), as seen in the buyer 1 line.

But, for a transaction / trade to happen a common ground has to be met. So, if the buyer number 1 is willing to match the seller number 1’s price, then the share price will be higher (Rs 2,342.7). If the seller number 2 is willing to match the price of buyer number 1, then the share price will be lower (Rs 2,341.85).

The share price keeps on changing during the day depending upon the frequency of transactions.

With routine/day-to-day developments and news flow about future prospects of a company, its share price changes. So if there are positive/better-than-expected developments regarding the company’s prospects then the demand for its shares will increase resulting in higher stock price and vice versa.

Let’s try to understand this from a recent example.

The recent buzz of Amazon Inc picking a 40% stake in Reliance Retail led to the stock rallying by ~7% in 2 days. (Both RIL and Amazon have declined to comment on the deal).

Some viewed this as positive development and bought RIL stock. Another set, comprising RIL's shareholders sold shares probably perceiving the stake sale as a negative development as CLSA had valued Reliance Retail at $75 billion against the transaction value of $57 billion.

Compared to this on April 22, 2020 when Facebook announced a 10% stake purchase for ~$5.8 billion, the stock rallied 14% in a couple of days.

The difference in perspective can also be skewed towards one segment of people for a certain period of time due to which the actions by those set of people will determine the movement of the share price and hence the prevailing value, in this case people who perceived Amazon deal as positive outnumbered others, leading to a spike in stock price.

So whenever a stock or an index hits upper or lower circuit limits then it reflects a uniform or across the board positive/negative bias, respectively.

So with respect to the example above, post April 22, 2020, almost all RIL investors were positive while those who thought otherwise were limited in numbers and hence the share price continued to rise.

Apart from company specific factors, the reasons for increase/decrease in a share price can be due to a variety of factors including fiscal policy, monetary policy, change in rules and regulations surrounding its business environment, perceived growth potential of the sector from the investor’s perspective, global issues/factors, et cetera.

~~~~~~~~~~~~~~

Amitabh Tiwari is a former corporate and investment banker turned political commentator and strategist. He tweets @politicalbaaba.

K Shankar is a MBA in finance with over 2 decades of experience in equity research and financial analysis.