How Do Institutional Investors Affect Stock Prices?

Institutional investors hold a powerful influence over the market, with their high-volume trades often impacting stock prices and shaping overall market trends.

By understanding how institutional investors affect stock prices, individual investors can make more informed decisions and better navigate market trends. This guide will explore how institutional influence shapes the market and how you can use this knowledge to your advantage.

Institutional investor definition

Institutional investors manage large sums of money. Their trades often involve millions of dollars, far larger than what typical retail investors invest. Because of this scale, any decision they make—whether to buy, hold, or sell—often creates noticeable changes in a stock’s price and trading volume.

Types of institutional investors include:

• Mutual funds;
• Hedge funds;
• Pension funds;
• Insurance companies;
• Endowment funds and foundations;
• Exchange-traded funds (ETFs).

How do institutional investors affect the stock market?

Institutional investors impact stock prices in several direct and indirect ways. So, let’s examine some primary mechanisms:

• Large-scale buying and selling: When institutional investors purchase large blocks of shares, it increases demand, which typically raises the stock price. In turn, mass selling typically drives the price down. Because institutional investors trade in such high volumes, their trades can make a ripple effect across the market;

• Influence on stock liquidity: Liquidity refers to how quickly and easily stocks can be bought or sold without affecting the stock’s price. Institutional investors improve liquidity by increasing trading volumes, making it easier for everyone to trade those stocks. Stocks with higher liquidity usually experience less drastic price swings, benefiting both institutional and retail investors;

• Market sentiment and signals: Institutional investors act as trendsetters in the stock market. When they buy a particular stock, others see it as a sign of confidence in that stock, often leading retail investors to follow suit. This herding effect can amplify price changes even further. Institutional endorsement often makes a stock more appealing to retail investors, fueling further demand and price increases;

• Corporate governance and influence: Many institutional investors take active roles in corporate governance. They might lobby for board seats or use voting rights to influence company decisions. Their involvement can drive management to make changes, potentially increasing the stock’s appeal to the market.

Institutional ownership and stock price impact

The level of institutional ownership in a stock often shapes its overall characteristics, influencing factors such as price stability, market sentiment, and corporate governance.

High institutional ownership tends to stabilize prices due to enhanced liquidity and greater investor confidence, while low ownership might mean more volatility and limited oversight.

Pros and cons of institutional ownership

Pros

• Institutional investors bring expertise and research resources, potentially boosting stock value;
• Large investments by institutions often indicate stability and attract other investors;
• Institutions are more likely to engage with company management, advocating for better governance;
• Their long-term perspective can reduce short-term volatility in stock prices.

Cons

• High institutional ownership can lead to increased volatility when large shares are bought or sold;
• Institutions may prioritize profit over a company’s social or environmental impact;
• Their influence might lead to pressure on management for short-term results rather than sustainable growth;
• Retail investors may have less sway over company decisions compared to institutional investors.

Institutional investors and stock market volatility

A 2006 study by Xavier Gabaix, Parameswaran Gopikrishnan, Vasiliki Plerou, and H. Eugene Stanley investigated how trades by large institutional investors can drive stock price fluctuations, even when no new information about a company emerges.

The researchers found that trades by these investors lead to significant spikes in returns and volume, particularly in less liquid markets, which can amplify stock price volatility. This study shows that large institutional trades influence market behavior, revealing how institutional size and trading volume contribute uniquely to price changes.

“Such trades generate significant spikes in returns and volume, even in the absence of important news about fundamentals.” — Gabaix, Gopikrishnan, Plerou, and Stanley

How to track institutional investing activity

Tracking the moves of institutional investors can give you a strategic advantage in the market. For example, Finbold Signals provides real-time updates about institutional stock trading, alerting you to any major buys or sells. It delivers updates through email, Telegram, and Discord, making it easy to stay up-to-date on market-moving trades.

The bottom line

Institutional investors hold considerable sway over the stock market. Their trades can significantly impact stock prices, liquidity, and even corporate governance. By understanding these dynamics, retail investors can navigate the market more confidently, aligning their moves with the powerhouses of the investment world.

Learning how to interpret the actions of institutional investors and using tools like Finbold Signals to stay informed will empower you to make smarter decisions, especially in today’s complex financial landscape. Keep an eye on these major players, as their moves often indicate larger trends and opportunities.

Disclaimer: The content on this site should not be considered investment advice. Investing is speculative. When investing, your capital is at risk.

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