Investing Assets & Markets Stocks How Are Stock Prices Determined? Understand the Factors Behind Stock Prices By Joshua Kennon Joshua Kennon Twitter Website Joshua Kennon is an expert on investing, assets and markets, and retirement planning. He is the managing director and co-founder of Kennon-Green & Co., an asset management firm. learn about our editorial policies Updated on March 21, 2022 Reviewed by Doretha Clemon Reviewed by Doretha Clemon Doretha Clemons, Ph.D., MBA, PMP, has been a corporate IT executive and professor for 34 years. She is an adjunct professor at Connecticut State Colleges & Universities, Maryville University, and Indiana Wesleyan University. She is a Real Estate Investor and principal at Bruised Reed Housing Real Estate Trust, and a State of Connecticut Home Improvement License holder. learn about our financial review board Fact checked by Julian Binder Fact checked by Julian Binder Julian Binder is a fact checker, researcher, and historian. They were the recipient of the North American Studies Book Prize (2016, 2017), and they have previous experience as an economics research assistant. They have also worked as a writer and editor for various companies, and have published cultural studies work in an academic journal. As a fact checker for The Balance, Julian is able to utilize their experience as an editor and economics research assistant. Their role as fact checker is to review articles for accuracy, update data as needed, and verify all facts by citing trusted sources. learn about our editorial policies In This Article View All In This Article Understanding Capital Markets How Stock Prices Are Determined Theories Behind Stock Prices The Bottom Line Frequently Asked Questions (FAQs) Photo: SARINYAPINNGAM / Getty Images For someone new to Wall Street, stock prices may seem mysterious. They go up and down; people make and lose money. But why do the prices move? Who or what decides where those stock prices land every day? While there are many factors that affect a stock's price, there are basic principles that can help give you a sense of why a stock is valued the way it is. To build foundational knowledge, we'll start off by explaining what the capital markets are and how they work. Then, we'll dive into how stock prices are determined. You'll learn about two essential theories: the Efficient Market Hypothesis (EMH) and Intrinsic Value Theory. Understanding Capital Markets A big part of understanding the rationale behind stock prices is understanding the capital markets in general. The capital markets, often simply referred to as "Wall Street," serve three main purposes. The Primary Market First, capital markets establish the primary market by connecting savers of capital with those who want to raise capital. In other words, a business owner who wants to start or grow a business can use the capital markets to connect with investors who have money to spare. Note There are two primary ways a business raises capital: the issuance of bonds and stocks. A company that issues bonds is essentially establishing a loan deal with an investor, and the company agrees to pay back the loan plus interest over a set timeline. A company that issues stock is selling partial ownership in the company. Instead of getting repaid, like a loan, the investor will instead sell that partial ownership at a later date—hopefully after the company has grown and increased its value. As the company's value rises, the stock's price does, too, though there are other factors to consider. The Secondary Market Secondly, capital markets facilitate a secondary market for existing owners of stocks and bonds to find others who are willing to buy their securities. The secondary market is complementary to the primary market through the liquidity it provides. Investors are more comfortable investing if they believe they can find someone to buy the securities they want to sell. Investment Professionals Lastly, capital markets provide a way for ordinary people to outsource their investment decisions. When investment decisions are handled by someone else, people can focus on their primary career or activity. Capital markets create the opportunity for institutions and individuals to invest on someone's behalf—for a fee. This investing is sometimes done through a broker-dealer. Increasingly, this is done through a firm that is a registered investment advisor (RIA). An RIA is bound by a fiduciary duty to put the interests of clients above the interests of the firm. Thanks to the capital markets, you can pay someone else to handle your portfolio. You can spend more time generating income and less time reading 10-K filings or mutual fund prospectuses. How Stock Prices Are Determined After shares of a company's stock are issued in the primary market, they will be sold—and continue to be bought and sold—in the secondary market. Stock price fluctuations happen in the secondary market as stock market participants make decisions to buy or sell. The decision to buy, sell, or hold is based on whether an investor or investment professional believes that the stock is undervalued, overvalued, or correctly valued. If a stock costs $100 but is believed to be worth $90, then it is overvalued in some people's view. If it is believed to be worth $110, then it is considered undervalued. So why would the stock price be $100 when it's potentially worth $90, or even $110 per share? It comes down to the supply and demand in relation to the volume of shares being bought and sold. It's the investors, or partial owners, buying and selling among themselves that determine the current market value of a trade. The Ask and the Bid The potential buyers announce a price they would be willing to pay, known as the "bid." The potential sellers announce a price they would be willing to sell, known as the "ask." A market maker in the middle works to create liquidity by facilitating trades between the two parties. Note Put simply, the ask and the bid determine stock price. When a buyer and seller come together, a trade is executed, and the price at which the trade occurred becomes the quoted market value. That's the number you see across television ticker tapes, internet financial portals, and brokerage account pages. Theories Behind Stock Prices While the ask and bid essentially create a stock's price, that doesn't touch on bigger issues like why a seller was willing to sell at a given price, or why the buyer was willing to pay a certain amount. Efficient Market Hypothesis Some people don't think there's a point in asking those deeper questions, and that kind of thinking is known as Efficient Market Hypothesis. The theory is that a stock price reflects a company's true value at any given time—regardless of what analysis of the company's fundamentals or broader market trends might suggest. EMH believers are proponents of passive investing, a strategy that takes a broad and neutral approach, as opposed to focused analysis and timing. The thinking is that no amount of research could predict the randomness of the market, so it's best to buy as broad a range of stocks as possible and hold onto those stocks for as long as you can. Note EMH is not a universally accepted theory, and it's actually highly controversial in some investing circles. Intrinsic Value Theory On the other side of the theoretical spectrum, you'll find Intrinsic Value Theory. This theory states that companies trade for more or less than what they are worth all the time. The company's real value, something Benjamin Graham called "intrinsic value," is the net present value of the owner's earnings. It is the cash that can be extracted from the enterprise from now until the end of time, based on the actual productive capacity of the business itself. In other words, how much money is the company making, and how long can it continue making that amount? Investors that follow this theory are "value investors." They include famous investors like Warren Buffett (whose mentor was Benjamin Graham). His widely attributed quips draw from this outlook, including his belief that "if a business does well, the stock eventually follows," and "it's far better to buy a wonderful company at a fair price than it is to buy a fair company at a wonderful price." When something causes a company's stock price to fall, a value investor will scrutinize it and decide whether it presents an opportunity to buy. The Bottom Line In order to understand how stock prices are determined, it's important to first know how the capital markets work. Within the capital markets, buyers and sellers collectively help determine the stock price. There are many factors and theories on why stock prices fluctuate, but two theories are the most cited. The Efficient Market Hypothesis says that a stock price reflects a company's true value at any given time. The Intrinsic Value Theory states that companies may trade for more or less than they are worth. Frequently Asked Questions (FAQs) How are IPO stock prices determined? During a stock's initial public offering (IPO), the market has not yet had a chance to determine a stock's value. The initial stock pricing is usually decided by the investment bank underwriting it, based on the value of comparable stocks, company financials, experience, and sales skills. How do you predict stock prices? There is no way to perfectly predict stock price movement, and different investors rely on different methods. Some rely on a stock's current momentum and direction, others analyze company details like price-to-earnings ratios, earnings per share, and more complicated metrics. Various methods can help you make informed decisions, but there is always some degree of risk and uncertainty involved. Where can you check stock prices? There are plenty of ways to keep up with stock prices online. You can check stock prices directly on the exchanges throughout the day, or on a variety of stock-tracking websites. There are also many apps and tools for day traders that can provide real-time stock charting down to the minute. Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. Farlex Financial Dictionary. "Primary Market." Farlex Financial Dictionary. "Secondary Market." Detchman Wealth Management. "What Is a Registered Investment Advisor?" Iowa State University. "What causes a stock's price to change?" NASDAQ. "Understanding The Benjamin Graham Formula Correctly."