Tesla has been one of the top performers this year. Yes, the Nasdaq 100 index made several new all-time highs during the pandemic. However, that is nothing compared to Tesla, which is up +622.49% year to date.
There are several reasons why the price of a stock rises. For this reason, it is important to understand the mechanisms involved when trading the stock market and what leads to a price increase or decline.
Before we start, it is mandatory to make a difference between shares and CFDs. Most brokers, especially the ones offering FX products, added “shares” or indices, which effectively are CFDs or Contracts for Difference. By buying or selling such a product you do not participate in the stock’s price action, but only speculate on its move.
What Makes Stocks Go Up or Down
Tesla is one of the tech stocks in focus during the pandemic. Despite being an automaker, it is viewed by many as a tech company. The entire tech sector was on the rise during 2020, but Tesla rose the most. How come?
First, the price of anything rises or falls with changes in demand. When the buying volume exceeds the selling one, the price rises. On the other hand when more sellers dominate the market the price falls.
While this is basic, in the stock market there is something called margin trading. Effectively, one may participate both in the long and the short side with more than the amount on the trading account.
For instance, buying on margin effectively means that the investor borrows money from the broker. So, if one thinks that the price of a Tesla share will triple in the next year or so, he or she may decide to buy it on margin, effectively buying more shares than the account allows. This puts upside pressure on the price stock. On the other hand, if the price declines, the trader will receive a margin call as the broker will automatically close the position the more the price declines.
Second, there is such a thing as a short squeeze. Shorting stocks is not lucrative, as the potential for losses is unbounded while gains are limited to 100% (i.e. the stock goes to zero). If the price rises, shorts are “squeezed” as they have to come up with more funds to cover for the rise. If they do not, the broker will buy back the borrowed shares, further fueling the price of the stock.
Up until 2020, Tesla’s stock was one of the most shorted in the world. Therefore, one plausible explanation is that shorts were squeezed to such an extent that they gave up, as reflected by the declining market value of Tesla shorts to only $19.5 billion.