Why do stock markets go up and down?

If you follow the news at all, you’ll have heard about stock markets going up and down. Sometimes dramatically. The FTSE 100 rises 2% on good news, falls 3% on bad. Sometimes markets crash. Sometimes they boom for years on end. What’s actually driving all of this?

The short answer is: a lot of things at once. But they broadly fall into two buckets — the economic and the emotional. Understanding both makes you a much better investor.

The economic drivers

Stock markets are ultimately a collective judgment about the future profits of thousands of companies. When the economic outlook improves — lower interest rates, rising consumer spending, strong employment — companies are expected to earn more money, so their shares become more valuable. When the outlook darkens, the reverse happens.

The key economic factors that move markets include:

Interest rates. This is probably the most powerful single force acting on stock markets. When interest rates rise, borrowing becomes more expensive for companies (which cuts into profits) and bonds become more attractive to investors (which pulls money away from shares). When rates fall, the opposite happens — shares look more attractive and borrowing is cheaper. This is why markets watch central bank announcements from the Bank of England and the US Federal Reserve so closely.

Inflation. Moderate inflation is normal and manageable. High inflation erodes company profits and forces central banks to raise interest rates to bring it under control — which then hits markets. The sharp falls in 2022 were largely driven by inflation running far above target and the aggressive rate rises that followed.

Economic growth. When GDP is growing, companies generally sell more and earn more. When growth stalls or turns negative — recession — profits typically fall. Markets often move before the official data confirms a recession, because investors are trying to anticipate what comes next.

Company earnings. Every quarter, listed companies publish their results. When profits beat expectations, the share price usually rises. When they disappoint, it falls. This company-level effect aggregates up across thousands of companies to move the whole market.

Global events. Wars, pandemics, energy crises, trade disputes — any event that disrupts the global economy or specific industries will feed through into share prices. The oil price shock of 2022 following Russia’s invasion of Ukraine hit energy-intensive sectors hard. Covid in 2020 hammered travel and hospitality overnight.

The emotional drivers

Here’s where it gets interesting. Markets don’t move purely on cold logic. They’re driven by millions of human beings making decisions under uncertainty, and humans are not rational calculators. Fear and greed play a huge role.

Sentiment and momentum. When markets are rising, optimism feeds on itself. Investors buy because prices are going up, which pushes prices up further. This is called a bull market. The same thing happens in reverse — falling prices trigger fear and selling, which drives prices lower still. Bear markets can take on a life of their own, well beyond what economic fundamentals alone would justify.

The herd effect. Most investors, professional and amateur alike, pay attention to what other investors are doing. When institutions start selling, others follow. When retail investors pile into a popular trade, it can drive prices to levels that look absurd in hindsight. The GameStop episode in 2021 was an extreme example of herd behaviour overpowering fundamentals entirely.

News flow and narrative. Markets respond to stories, not just numbers. A company can have strong earnings but fall on a disappointing outlook statement. A sector can crash on a single alarming headline. The way information is framed matters as much as the information itself.

Fear of missing out. In bull markets, investors who sit on the sidelines watching prices rise often feel compelled to pile in near the top — just in time for a reversal. This is one of the most reliable patterns in investing and one of the most expensive mistakes individual investors make.

Bull markets, bear markets and corrections

A bull market is a sustained period of rising prices — typically defined as a rise of 20% or more from a recent low. Bull markets can last years. The period from 2009 to 2020 was one of the longest bull markets in history.

A bear market is the reverse — a fall of 20% or more from a recent peak. Bear markets tend to be shorter and sharper than bull markets, but they feel worse because humans feel losses more acutely than equivalent gains.

A correction is a smaller pullback — typically defined as a drop of 10% or more. Corrections are normal and happen regularly. They can feel alarming but are a healthy part of how markets work.

The important thing to understand is that bear markets, however painful, have always eventually given way to new bull markets. Markets are not a one-way bet — but over long periods, they have historically risen more than they have fallen.

Why short-term noise is not the same as long-term direction

Day-to-day market moves are mostly noise. A single day’s fall of 1% tells you almost nothing meaningful about the health of the companies in your portfolio. Markets overreact to news in both directions, then correct. Investors who check their portfolio every day and react to every move tend to do worse than those who check quarterly and stay the course.

The data on this is very clear. Missing just the ten best trading days in any given decade can cut your total returns by more than half. Those best days very often come immediately after the worst days — when markets bounce back sharply from a panic. Investors who sell during the panic miss the recovery.

This is not an argument for ignoring your investments. It is an argument for having a long-term plan and sticking to it, rather than trying to time the market based on how you feel about this week’s headlines.

TL;DR — the short version

• Markets go up and down based on a mix of economic fundamentals (interest rates, inflation, growth, earnings) and human emotion (fear, greed, momentum)
• Interest rates are the single most powerful driver — when they rise, shares tend to fall; when they fall, shares tend to rise
• Bull markets are sustained rises of 20%+ from a low; bear markets are falls of 20%+ from a peak; corrections are 10%+ drops
• Bear markets are painful but have always eventually ended — history shows markets recover
• Short-term moves are mostly noise — investors who react to every dip tend to do worse than those who stay the course
• Missing the best days in a market recovery can dramatically reduce long-term returns

---

This article is for information only and does not constitute financial advice. The value of investments can go down as well as up. If you are unsure about whether an investment is right for you, seek advice from a qualified financial adviser.

This article is for informational purposes only and does not constitute financial advice. Investment values can go down as well as up. Always do your own research before making any financial decisions.