STOCK PRICE

MOVEMENT
By Arqk Maheshwary
WHAT IS STOCK MARKET?
The stock market refers to the collection of markets and exchanges where
regular activities of buying, selling, and issuance of shares of publicly-
held companies take place. Such financial activities are conducted through
institutionalized formal exchanges or over-the-counter (OTC)
marketplaces which operate under a defined set of regulations. There can
be multiple stock trading venues in a country or a region which allow
transactions in stocks and other forms of securities.
STOCK MARKET OF INDIA
Most of the trading in the Indian stock market takes place on its two stock
exchanges: the Bombay Stock Exchange (BSE) and the National Stock Exchange
(NSE). The BSE has been in existence since 1875. The NSE, on the other hand, was
founded in 1992 and started trading in 1994. However, both exchanges follow the
same trading mechanism, trading hours, and settlement process.
As of February 2020, the BSE had 5,518 listed firms, whereas the rival NSE had
about 1,799 as of Dec. 31, 2019. Out of all the listed firms on the BSE, only about
500 firms constitute more than 90% of its market capitalization; the rest of the
crowd consists of highly illiquid shares.
Almost all the significant firms of India are listed on both the exchanges.
EFFICIENT MARKET HYPOTHESIS (EMH)
The efficient market hypothesis (EMH), alternatively known as the efficient market
theory, is a hypothesis that states that share prices reflect all information and consistent 
alpha generation is impossible.
According to the EMH, stocks always trade at their fair value on exchanges, making it
impossible for investors to purchase undervalued stocks or sell stocks for inflated
prices. Therefore, it should be impossible to outperform the overall market through
expert stock selection or market timing, and the only way an investor can obtain higher
returns is by purchasing riskier investments.
The efficient market hypothesis (EMH) or theory states that share prices reflect all
information.
The EMH hypothesizes that stocks trade at their fair market value on exchanges.
METHODS OF PREDICTING STOCK
PRICES
1. Binomial Distribution
The future price movement of a stock can be approximated using Binomial Distribution. Lets
say the current stock price is ‘S’. The price of the stock can either move up or move down. We
will refer the up-movement as ‘u’ and the down movement amount as ‘d’. A down movement d
will then be given by ‘d’. Where ‘d’ is assumed to be equal to 1/u(d=1/u). We also need the
probability of an up move (p) and the probability of a down move (1-p) in ‘t’ time periods.
An upward movement in share price can be considered as a successful result while a
downward movement can be considered as a failed result.
To explain the price change in a stock in one time period, the following diagram can be
referred to:
From the given two points (Su and Sd), the share price can again take two possible
changes:-

I. Su can move to Suu or Sud(Sud = S since S*u*1/u = s)

II. Sd can move to Sdu (Sdu = S since s*1/u*u = S) or Sdd

Similar to the diagram above, the price changes can be shown for multiple periods.
The figure so formed is called the Binomial Tree.
The Binomial tree on the next slide shows the share price changes for 4 periods,
where S0 is the initial price per share of the given firm:
The following example will help us understand better:-

Q. Let the initial stock be $20 with an upward movement amount, u = 1.02 and
probability of share price going up, p = 0.60. Find the possible share prices after 3
periods. Also find the probability of the share being $21.22.
Solution:
S= $20
u= 1.02
D= 1 / 1.02
p= 0.6
Therefore, down move = (1 - p) = (1 - 0.60) = 0.40
Therefore, down move = (1-p)=(1-0.60)=0.40

Possible stock values for period 1:

I. Su= 20 * 1.02 = $20.40 with a probability of 0.60
II. Sd= 20 * 1/1.02 = $19.60 with a probability of 0.40

Possible stock values for period 2:-

III. Suu= $20.81 with probability of 0.60*0.60 = 0.36
IV. S= $20 with probability of 2*0.60*0.40 = 0.48
V. Sdd= $19.22 with probability of 0.40*0.40 = 0.16
◦ Similarly, the possible stock values for period 3:-
I. Suuuu= $21.22 with probability 0.60*0.60*0.60*0.60 = 0.216
II. Su= $20.40 with probability 3*0.70*0.60*0.40 = 0.432
III.Sd= $19.60 with probability 3*0.60*0.40*0.40 = 0.288
IV. Sddd= $18.84 with probability 0.40*0.40*0.40 = 0.064
THE END