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We've seen this scenario several times over the past few weeks: The major stock market indexes will plummet one day and then rise dramatically (though perhaps not to the previous days starting price) on the following day. Yes, in some of the cases there was a policy pronouncement or some such that might have had some effect, but usually not.

One would think that traders, if they were doing a normal risk/benefits analysis, would not change strategies so abruptly. Is there some non-obvious benefit to abruptly "betting" one direction and then the other, or is some sort of mechanical market force at work?

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  • $\begingroup$ To make it clear, I'm just trying to understand what mechanisms drive this behavior. $\endgroup$
    – Hot Licks
    Commented Mar 20, 2020 at 17:19
  • $\begingroup$ "in some of the cases there was a policy pronouncement or some such that might have had some effect, but usually not" Evidence for this claim? Especially for dramatic changes? Typical example of bad question: "Why is X [usually] happening", when X is not [usually] happening. $\endgroup$
    – got trolled too much this week
    Commented Apr 3, 2020 at 5:14
  • $\begingroup$ Relevant (I suppose) to this question: New York Times: But simultaneously, stock investors are betting that powerful interventions out of Washington — including an additional $2.3 trillion in lending programs from the Federal Reserve announced on Thursday — will be enough to enable major companies to emerge with little damage to their long-term profitability. $\endgroup$
    – Hot Licks
    Commented Apr 10, 2020 at 20:34

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Stock prices are determined at the marketplace. However, just like you stated, there is not a clean connection that tells us exactly how a stock price will go up or down. However, three are three main category of forces that impacts stock prices. Those are fundamental factors, technical factors, and market sentiment.

fundamental factors, at a very basic level in an efficient market stock prices would be moved by ratios or data that comes from a company's balance sheets. Two of those are earnings per share and P/E ratio.

Earnings-per-share is company's profit divided by the outstanding shares of its common stock. The P/E ratio is current share price relative to its per-share earnings. representing an anticipated future earnings stream. Many use cash-flow-based measures to determine whether they buy or not. They also use it to see the perceived risk of the stock.

technical factors are mix of external conditions that alter the supply of and demand for a company's stock. For example, the growth in gdp.

But here is a list of other economics indicators that can have an technical impact on whether someone buys or not:

Inflation

Production output growth of industry/market

Incidental transactions: purchase or sale of a stock motivated by something other than the value of the stock.

Demographics of investors. Are they middle aged or older investors.

Trends in the market.

News: what is happening in the world can impact a company finances. Political situations or negotiations between countries can and does have an affect too.

market sentiment, which is referring to how market participants believe or feel, individually and collectively. This is the most frustrating category. Market sentiment is often biased.

The question asked was “is there some non-obvious benefit to abruptly "betting" one direction and then the other, or is some sort of mechanical market force at work”.?

To answer that I would say, "possibly"; because of market sentiment of a particular demography of market participants. They may get the pleasure of feeling good about betting in a particular way when to others it is non-obvious to do that.

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In short...human nature! (I'm only half-kidding). Of course, mechanically, what drives these abrupt changes is simply a large amount of buyers one day...and a large amount of sellers the next.

A great metaphor you might like is Mr. Market. Also this video of Warren Buffett talking about Mr Market. It's just a metaphor used to show how capricious, and seemingly irrational, the market can be.

I don't think there's some philosophically deep mechanism at play (other than human nature). Maybe you could make the argument that new information comes out that justifies a 5-10% swing...but that argument seems flimsy to me.

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  • $\begingroup$ But, human nature being what it is, the tendency of most people is to stick with a decision even in light of evidence that it was a bad decision. This would explain longer-term ups and downs, but not the daily flip-flop we've seen recently. $\endgroup$
    – Hot Licks
    Commented Apr 2, 2020 at 2:14
  • $\begingroup$ Hmm...sure, but there are multiple phenomena at play. There is also a concept of [Overtrading][1]. I.e. that people get caught up in the news cycle & start becoming over-active with their investments. Another way volatility happens (on the way down) is through margin calls. I.e. there is forced selling. If I can't pay for my kid's dinner, I may HAVE to sell my stocks...no matter how unattractive the price. [1]: investopedia.com/terms/o/overtrading.asp $\endgroup$
    – David
    Commented Apr 2, 2020 at 2:19
  • $\begingroup$ What you describe in your comment would mostly cause downward motion, not upward. $\endgroup$
    – Hot Licks
    Commented Apr 11, 2020 at 12:36

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