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Why Do Share Prices Rise and Fall?

The question in the title might be a little unfair. After all, if share prices are inherently unpredictable (and in one sense, they are - more on that later), there's no answer.

Nevertheless, over a period of decades the stock market has had better returns than any other investment - 8-12% depending on various factors and it's one of the most widely studied markets on Earth. With that kind of historical data and brain power to lean on, one should be able to make a few valid observations. Well, here are some. You judge their validity.

In the long run, there's no doubt share prices are heavily influenced by earnings. When companies make money, consistently over long periods, investor confidence grows and bid the price of shares up. What influences earnings and confidence?

Everything from interest rates to debt load, taxes, lawsuits, management, technological and other social changes, and the general economy affect earnings - both short and long term.

Almost all companies borrow money and even when they don't their competitors, suppliers and customers do. That affects how much money they have to invest in research and new products or improving existing ones, relative to other companies in the similar lines of business.

Sometimes even stellar managers can be threatened by social or technological changes, unless they evolve the company to adapt. In that case, a company which once sold light bulbs - and made good profits doing so - can become an almost entirely different company in time. General Electric - the only original Dow stock that is still part of the DJIA (Dow Jones Industrial Average) - is an excellent example.

Over shorter time frames, influences become even more numerous and harder to quantify. Everything from the latest analyst recommendation and rumor or actual news event to fraud, the herd mentality and a blizzard of technical factors plays a part.

Google's share price quadrupled in a two year time frame and is projected to grow yet another 50% over the next year. Microsoft - once the most reliable growth stock in the world, even ridiculously so as admitted by its senior executives - has been in the doldrums for years now. Earnings alone can not explain these and other, similar, cases.

Share prices today are in large part due to expectations of what the price will be tomorrow next month or next year. That expectation is affected by technical analysis (which may or not be well founded) and sheer guesses about what other investors are thinking or will think. Along with these there are occasional out and out cases of fraud, lawsuits from nowhere and other unexpected circumstances.

Political changes play a part, and sometimes they too are unexpected by most investors. No one can say when or whether a tax bill will pass that reduces or increases corporate rates. The election of a new Prime Minister or President can have a large, short term affect or longer, sometimes, depending on the individual.

And, then there's the inherent unpredictability mentioned earlier. Short-term, and to some degree long-term, prices are a statistical phenomenon. As with any statistical effect you can't make a prediction - except with some degree of probability. And, since investors - some of whom own large blocks - can change their minds on a whim, you can only make educated guesses about what or when those choices will be.

So, what's the average investor to do? That depends on the kind of investor you want to be.

For those with the talent and time to do intense moment-by-moment research, it is possible to do well in short-term trading. Though almost all day traders lose money. For those, even big risk takers, who are more inclined to fundamental factors and willing to research long-term trends - take comfort in the fact that 8-12% return over decades is as good a prediction as you need.