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The conversations on price changes in the equity market are usually focused on factors like valuations, stock index prices, earnings growth etc. However, it is important to know how basic laws of economics of supply and demand affect the movements of the market.
Harshad Patwardhan, CIO, Union MF explained how the supply demand dynamic plays out in the context of the equity market and its effect on stock price at the recently concluded Cafemutual Ideas Fest 2025.
Understanding price movements using Newton’s laws
It is important to understand that any fundamental factor does not affect the price until it creates a change in supply and demand. Market price is set when incremental demand is met by incremental supply.
Similar to Newton’s first law of motion, an unbalanced force is required to move the prices. For instance, a fund manager interested in buying large quantities of a stock will be ready to offer a higher price to the seller, thereby acting as an unbalanced force which leads to an increase in the price. Alternatively, a fund manager who wants to redeem large quantities of shares of a company, may offer a lower price to attract buyers, thereby acting as a force to decrease the price of the stock.
Newton’s second law of motion also applies to stock price movement. For example, a fund manager can offer a higher price to buy an illiquid stock he is bullish about, which will increase the stock price sharply. The acceleration in the stock price is proportional to the force which is the quantity of the fund manager’s purchase while the low mass here is the low liquidity of the stock.
Effect of price on demand and supply
The increase in price of a security leads to an increase in its demand as people want to chase the momentum of increasing prices. This, in turn, further increases the demand.
The demand of Indian markets is currently dominated by domestic investors. The demand of Indian equity has decreased among foreign investors in recent years which has been compensated by the increase in investment by the domestic investors. In percentage terms, investment by foreign investors constituted 4-5% of the market cap during 2007-08 which has decreased substantially in recent years.
The supply in recent years has been provided primarily by selling from long-term investors. However, due to the good performance of the market, the supply has been lower than demand in the last few years.
What happens next?
The future of the Indian equity market is dependent on multiple factors. This includes how the supply in the market adjusts to the reduced demand. It will also depend on the behavior of FIIs which will be based on the US policy decisions and the policy of the Chinese government.
However, the most important factor which will determine the future of the Indian equity markets in the near term is the behavior of the domestic Indian investors and how they respond to the volatility in recent months. Resilience and courage of domestic investors in the next few months will determine the course of the Indian markets.
You can watch the complete session by clicking here.
