Here's How The Laws Of Supply And Demand Lead To Major Moves For Growth Stocks
The laws of supply and demand seem simple on their face, but understanding the subtle nuances is key for stock investors who want to take advantage of major price moves.
Supply and demand is one of the bedrock principles of business and economics. A simple example is how the price of lumber skyrocketed amid Covid-related shortages.
In the stock market, the companies seen as the best positioned by big money will see their share price driven higher as demand ramps up. When this happens, supply will also be constricted, as holders will be more reluctant to sell their shares. Thus, supply and demand is a key part of IBD-style investing.
↑ X Danger Ahead: This Sell Signal Tells You When To Get Out Of A Highflying StockLegendary IBD founder William O'Neil, writing in his classic tome, "How to Make Money in Stocks," said supply and demand is "more important than the opinions of all the analysts on Wall Street, no matter what schools they attended, what degrees they earned, or how high their IQs."
Float Size Matters
A key point to bear in mind is whether the stock you are eying has a large or a small float: the number of shares available for trading. Getting locked into a stock with a small supply of shares means you can be taken on wild rides, both on the upside and the downside.
On the other hand, investing in a big-cap name with a massive amount of shares outstanding means it is much more difficult for that stock to make big moves. On the plus side, this can also be less stressful on one's stomach.
The ideal is to find a happy medium — a stock that boasts strong earnings growth, and one that is still expanding by offering new products and services. Also look for one that is attracting the attention of institutional investors. Nevertheless, stocks of companies with any size of capitalization can be bought by investors who follow IBD's approach.
Other encouraging signs to look for are companies that are buying back their stock, which reduces the supply of shares in the market.
How do you measure demand?
As is often the case when researching a stock, charts are key. Look at the average daily trading volume. Days where the number of shares traded is much higher, or lower, than normal are a key indicator.
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When a share price spikes in big trading volume, this is a clear sign of institutional demand. It is a key indicator that mutual fund managers and other big money buyers, who account for most trading in the stock market, are snapping up a stock. This sort of accumulation is the main driver for big price moves.
Piggybacking on such action is a proven way for the intelligent investor to succeed. But make sure to carefully study price charts to find stocks that are breaking out of proper bases or rebounding from price support levels. When a stock tops a buy point, ideally volume will be at least 40% above average.
The IBD Stock Checkup is another key tool. Under the supply and demand section, you'll find pass or fail ratings for all key related criteria.
That includes information on a stock's market capitalization and its Accumulation/Distribution Rating, which gauges institutional buying and selling over the previous 13 weeks. Also, the percentage change in funds owning a stock and the number of quarters of increasing fund ownership. Look for stocks flashing green lights in all of these areas.
