The amount of writing and analysis on the stock market is virtually endless. Every “stock guru” has a group of pet theories in his stable. One central factor has the most effect on short-term price changes in the stock market: the psychological state of investors. This means, of course, that the market has less to do with value, production or economic health than with the expectations and ideas of the dominant investors in a specific stock or sector.
Companies can make announcements. They can be sued. They can come up with products that will change the world. They can lay off thousands of workers, or hire them. All of these bits of information are important to consider when weighing investments. The real problem is that, in and of themselves, they mean nothing in terms of short-term stock prices. This sort of information must be acted upon in order to be useful. This kind of news is acted upon often in the short term, but if the issue passes with no real impact, the long-term effect is often minimal. News is important for short-term effects on prices, but this is only because of its psychological effect. The news need not be true or accurate. The point is that it is not so much the news that matters, but its effect on investors. If investors trust media reports, it will have a powerful short-term effect. If they do not, then it will be ignored by major market players.
When information is digested and put into effect, this causes a “herd” effect. For example, a firm is being sued by the federal government for gross environmental crimes. This news comes over the newswires and the Internet. The most important investors in that firm quickly move to dump the stock, fearing it will bottom out quickly. The price of the stock, therefore, plummets within minutes of the announcement. It is not so much that the firm is being sued, but rather that a) investors think the firm will lose, b) important investors sell quickly and c) competitors' stock goes up. These ingredients make up “investor sentiment” in this example.
Investor sentiment is the single most important element in short-term stock prices. “Sentiment,” can be further broken down into two segments. The first is media control. The media may choose to ignore important information while promoting other aspects of market news. It may play down lawsuits but play up sensational stories about mass layoffs. This produces false impressions, since one issue is played up over another, and yet still helps manipulate short-term prices. The second segment is dominance. Investors are not equal. The most important investors are those who control a large percentage of the outstanding stock. If they dump, or tell everyone that they are dumping, that means far more than if the small, middle-class investor decides to sell.
The complexity of “investor sentiment,” therefore, suggests that the market, at least in the short term, is more an exercise in psychology than economics. The influence of investor sentiment can begin at the top or bottom. If a group of investors want to sell their 10 percent of British Petroleum's outstanding stock, the media may report this as an extraordinary turn of events, which may influence smaller investors. Alternatively, albeit rarely, a large group of smaller investors may sell due to what they “hear” about BP, which in turn may bring larger investors to follow suit. In any case, investor sentiment remains an independent and powerful variable in these short-term price changes.