4 Factors That Shape Market Trends

Trends are what allow traders and investors to capture profits. Whether on a short- or long-term time frame, in an overall trending market or a range of environment, the flow from one price to another is what creates profits and losses. There are four major factors that cause both long-term trends and short-term fluctuations. These factors are government, international transactions, speculation and expectation and supply and demand.

Tutorial: Economic Indicators To Know

Learning how these major factors shape trends over the long term can provide insight into how future trends may occur. Here are the four major factors:

1. Government
   Government holds much sway over the free markets. The fiscal and monetary policies that governments and their central banks put in place have a profound effect on the financial marketplace. By increasing and decreasing interest rates, the U.S. Federal Reserve can effectively slow or attempt to speed up growth within the country. This is called monetary policy. If government spending increases or contracts, this is known as fiscal policy and can be used to help ease unemployment and/or stabilize prices. By altering interest rates and the amount of dollars available on the open market, governments can change how much investment flows into and out of the country. (Learn more in our Federal Reserve Tutorial.)
2. International Transactions
   The flow of funds between countries effects the strength of a country's economy and its currency. The more money that is leaving a country, the weaker the country's economy and currency. Countries that predominantly export, whether physical goods or services, are continually bringing money into their countries. This money can then be reinvested and can stimulate the financial markets within those countries.

These factors can cause both short- and long-term fluctuations in the market, but it is also important to understand how all these elements come together to create trends. While all of these major factors are categorically different, they are closely linked to one another. Government mandates can effect international transactions, which play a role in speculation and changes in supply and demand can play a role in each of these other factors.

Government news releases, such as proposed changes in spending or tax policy, as well as Federal Reserve decisions to change or maintain interest rates can also have a dramatic effect on long term trends. The lowering of interest rates and taxes can encourage spending and economic growth. This in turn has a tendency to push market prices higher. However, the market does not always respond in this way because other factors may also be at play. Higher interest rates and taxes, for example, can deter spending and result in a contraction or a long-term fall in market prices.

In the short term, these news releases can cause large price swings as traders and investors buy and sell in response to the information. Increased action around these announcements can create short-term trends, while longer term trends may develop as investors fully grasp and absorb what the impact of the information means for the markets.

International transactions, balance of payments between countries and economic strength are harder to gauge on a daily basis, but they also play a major role in longer-term trends in many markets. The currency markets are a gauge of how well one country's currency and economy is doing relative to others. A high demand for a currency means that currency will rise relative to other currencies.

The value of a country's currency can also plays a role in how other markets will do within that country. If a country's currency is weak, this will deter investment into that country, as potential profits will be eroded by the weak currency. 

The analysis and resultant positions taken by traders and investors based on the information they receive about government policy and international transactions create speculation as to where prices will move. When enough people agree on one direction, the market enters into a trend that could sustain itself for many years.

Trends are also perpetuated by market participants who were wrong in their analysis. When they are forced to exit their losing trades, it pushes prices further in the current direction. As more investors climb aboard to profit from a trend, the market becomes saturated and the trend reverses, at least temporarily. 

Supply and demand effects individuals, companies, and the financial markets as a whole. In some markets, such as commodities, supply is determined by a physical product. Supply and demand for oil is constantly changing, adjusting the price a market participant is willing to pay for oil today and in the future.

As supply dwindles or demand increases, a long-term rise in oil prices can occur as market participants outbid one another to attain a seemingly finite supply of the commodity. Suppliers want a higher price for what they have and higher demand pushes the price that buyers are willing to pay.

The financial markets have a similar dynamic. Stocks fluctuate on a short and long-term scale, creating trends. The threat of supply drying up at current prices forces buyers to buy at higher and higher prices, creating large price increases. If a large group of sellers were to enter the market, this would increase the supply of stock available and would likely push prices lower. This occurs on all time frames. 

As stated above, trends are generally created by four major factors: government, international transactions, speculation/expectation and supply and demand. These areas are all linked as expected future conditions shape current decisions and those current decisions shape current trends. Government effects trends mainly through monetary and fiscal policy. These policies effect international transactions which in turn effect economic strength. Speculation and expectation drive prices based on what future prices might be. Finally, changes in supply and demand create trends as market participants fight for the best price.