One of the basic principles of economics is that the price of a commodity will (in a free market) stabilize at an equilibrium at which the price that sellers are willing to sell meets the price that buyers are willing to buy. In this sense, the going price for the commodity may be viewed as a valuation of that quantity - the market forces have determined that this commodity represents this particular value. My question concerns stock prices, and my suggestion is that they do not represent an assessment that the stock is worth any particular price, but rather an assessment of the likely direction that they will take relative to the current price. This is due to the fact that very few people purchasing stock have any actual use for the stock, and are merely purchasing with the intention of ultimately reselling it. In the case, it would seem that the actual price is merely the accidental intersection of buying and selling pressure, and not much more. New buyers or sellers will take the current price as a given, and make a judgement primarily on prospects for the stock doing better or worse than it is now - no judgement of the current price is necessarily being made at all.
Now it is true that in cases of stocks that are egregiously over or undervalued, there will be a corrective adjustment made. This is due to the fact that the under or overvaluing will in such instances be themselves interpreted as evidence with regard to future stock movement relative to today. Simply put, the trader will buy or sell them thinking himself to be ahead of a curve which will follow when others catch on. Not due to the fact that he is getting a specific value today. I would suggest that this will manifest itself at extreme levels, but that there may be a large zone in which the price can fluctuate independent of such considerations.
This question is somewhat theoretical, but it does have practical considerations as well. In fact the inspiration for the question is a particular stock in which I have a position. This stock had been undergoing a slow but steady rise since the beginning of the year, but suddenly increased by about 75% over the course of the last week. This correlates with the fact that an investment fund controlled by Merrill Lynch has been steadily increasing its position in the stock over this time. At some point this added buying pressure will be removed, and the question is what happens next?
I see two scenarios, dependent on the question here. 1, it drifts back down until it hits the trajectory that it would have been on absent the temporary manipulation. Or 2, it reverts to the old trajectory, but uses the current value as the new starting point. (All this absent other considerations of course). This is dependent on the question raised above. If any given price can be regarded as a valuation by the market at that price then one could expect the stock to revert back to this price once the temporary price manipulation passes. But if only buying or selling pressure count, then the new price is as valid as the old one, and one would expect this price to become the new starting point for the pressure.
(Note to the moderators - I am not quite sure if this belongs in GD or GQ. I would imagine that this would depend on whether this topic has been dealt with by economists and stock market theorists. Feel free you move it as you see fit. Also, I’m not asking for advice in my specific instance, which is complicated by numerous other factors, but have used this example purely for illustrative purposes.)