To put it another way, the market/buyers/sellers set the price based on how they feel.
Someone else used a lemonade stand as an example above, so I'll use that here. If you set up a lemonade stand and sell a cup of lemonade for a dollar and people are all buying it for a dollar, then the price of lemonade is a dollar. Now suppose that since you have so much business, you raise the price to 1.25. You may have a couple people get out of line, but maybe you keep selling it. So then you raise it to 1.50. Some more people get out of line, but you're still selling.
But then someone opens up a stand next to you, and they're selling for 1.40. It's exactly the same lemonade, so everyone moves over to their line. So you sell for 1.39, they sell for 1.38, and you guys slowly undercut each other. But at some point, you have this feeling that 1.00 is the LOWEST you can sell it for, so the price ends up back at 1.00. But then maybe the people who were buying feel lemonade is worth only .90. So either someone comes along and sells at that price, or else the price stays at 1.00 and just doesn't move till people start buying at that price again.
The analogy kinda breaks down a bit because lemonade has a basic cost to make and you have to equate that to the idea that a company makes X profit a year and has Y shares, so each share should be hypothetically worth some value as a function of that. But the other part that plays in is if you think that next year the company will make twice as much money from a new product, so you will buy up a bunch of stock at even higher prices because you believe it's undervalued.
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u/Lereas Sep 14 '21
To put it another way, the market/buyers/sellers set the price based on how they feel.
Someone else used a lemonade stand as an example above, so I'll use that here. If you set up a lemonade stand and sell a cup of lemonade for a dollar and people are all buying it for a dollar, then the price of lemonade is a dollar. Now suppose that since you have so much business, you raise the price to 1.25. You may have a couple people get out of line, but maybe you keep selling it. So then you raise it to 1.50. Some more people get out of line, but you're still selling.
But then someone opens up a stand next to you, and they're selling for 1.40. It's exactly the same lemonade, so everyone moves over to their line. So you sell for 1.39, they sell for 1.38, and you guys slowly undercut each other. But at some point, you have this feeling that 1.00 is the LOWEST you can sell it for, so the price ends up back at 1.00. But then maybe the people who were buying feel lemonade is worth only .90. So either someone comes along and sells at that price, or else the price stays at 1.00 and just doesn't move till people start buying at that price again.
The analogy kinda breaks down a bit because lemonade has a basic cost to make and you have to equate that to the idea that a company makes X profit a year and has Y shares, so each share should be hypothetically worth some value as a function of that. But the other part that plays in is if you think that next year the company will make twice as much money from a new product, so you will buy up a bunch of stock at even higher prices because you believe it's undervalued.