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In 2025, President Trump signed executive orders imposing sweeping tariffs on imports from nearly all major trading partners. The measures set a baseline 10% tariff on all goods, with even higher, country-specific rates. Almost immediately, global markets sold off – the S&P 500 alone shed nearly $2 trillion in value.
Many observers anticipated tariffs, but few foresaw their scale and aggressiveness. That element of surprise is what makes this a textbook example of an external shock. But how do shocks like these actually move stock prices? In this article, we’ll explore stock price movements, and we will focus on external shocks and unforeseen events. First, let’s learn how markets normally set prices.
How Markets Normally Set Prices
Unlike a regular market, where you exchange money for goods or services, the stock market involves exchanging a claim on future value. You purchase shares in a company, which gives you the right to that company’s potential profits or even losses. That’s why the stock market feels more like a living thing; it reacts to news, psychology, and expectations.
But the stock market might also come across as a giant auction. Buyers place bids and sellers set asking prices. And where the two (‘bid’ and ‘ask’) meet becomes the market price. This process is called price discovery.
In a calm market, price discovery is smooth because there is enough buying pressure to feed the sellers. And the reason buyers balance out the sellers is liquidity. Investors define liquidity as the ability for orders (both ‘Buy’ and ‘Sell’) to be fulfilled without delays, and without moving the price too much. But when an unexpected event shifts the balance, supply and demand no longer meet in their usual way, and prices can swing sharply. That’s when external shocks make their mark.
Understanding “External Shocks”
The primary product in the stock market is shares in companies. And what a particular company does (or doesn’t do) determines the price movement of its stock. But sometimes events that originate outside of the company, or even outside of the stock market itself, manage to move the stock prices. These events define ‘external shocks’. Examples include sudden policy changes (like Trump’s tariffs), natural disasters, or geopolitical conflicts.
Regardless of their nature, external shocks have common characteristics. First, they’re unexpected or sudden; even if people saw warning signs, the timing or magnitude catches markets off guard. Second, they have no bearing on a company’s internal operations or performance. And third, they rarely affect just one stock. More often, they ripple across entire sectors or markets at once.
Why Do They Matter?
Earlier, we mentioned Trump’s tariff decree. Up until the announcement on April 2, 2025, the S&P 500 was relatively calm. But in the days that followed (through April 8), the index slumped 12.14%. Nothing of substance had changed within the affected companies. Their management teams hadn’t missed earnings or launched bad products. The shock came entirely from outside, yet investors still rushed to sell.
Source: Google Finance
If anything, this event teaches that stock prices don’t just reflect how well a company is doing today. They mirror investor expectations about how well that company will do in the future, given the world it operates in. When external shocks hit, they rewrite the rules of that world. Supply chains that seemed reliable become uncertain. Trade relationships that appeared stable turn fragile. Growth projections that looked reasonable suddenly seem optimistic.
How Shocks Transmit Into Prices
Knowing what qualifies as an external shock is only half the story. The real question is how these events ripple through the market and end up moving stock prices. Shocks don’t push prices directly; instead, they work through several channels – from liquidity and investor psychology to changes in fundamentals. Understanding these channels, you can easily see why the same event triggers a mild dip in one case and a full-blown selloff in another.
Liquidity
When an unexpected event occurs, liquidity is often among the first casualties; it evaporates. This is to say that investors cannot exit their holdings with ease or acquire new shares fast enough without moving the price needle too much. Now, normally, market makers smooth this process, which keeps bid-ask spreads narrow. But external shocks typically cause many investors to step back at once. Selling pressure surges, and suddenly, even small orders can move prices dramatically.
Even market makers see it fit to widen their spreads to protect against risk. And the problem snowballs: fewer trades are completed, and prices begin to gap lower. For instance, when fear grips the market, sentiment alone might trigger selling – but if liquidity is thin at the same time, those price drops accelerate sharply.
Volatility and fear
Shocks are often accompanied by heightened uncertainty. Investors read this uncertainty (and fear) as volatility. Volatility is merely a measure of how much stock prices swing and to what extent. The reality is that stock prices gain and lose even under normal conditions. But the frequency and extent of these movements are much more vigorous in a choppy market. The reason is that higher volatility makes investors demand higher returns to compensate for the increased risk. This is called a risk premium.
The options market provides a real-time gauge of investor sentiment, or fear. When shocks hit, the prices of options skyrocket. A popular tool that investors use to measure volatility (and fear) is the Chicago Board Options Exchange’s CBOE Volatility Index (VIX). The market is in panic mode when the index is elevated. During the stretch when the S&P 500 slumped close to 13% in April, the VIX hit its highest peak since April 2020 (during the coronavirus pandemic).
Source: TradingView
Volatility eventually surfaces liquidity issues. When prices swing uncontrollably, market makers face increased risk, and to remedy the situation, they widen bid-ask spreads even further. And as fear spreads through headlines and trading screens, more investors head for the exits. Put simply, volatility creates a self-reinforcing cycle that pushes prices lower.
Information and sentiment
Markets are highly sensitive to news. A single headline can shift expectations within minutes, prompting investors to revalue entire sectors. Shocks feed into this mechanism by creating a sudden flood of new information – often negative or uncertain. Even if the underlying facts are still developing, perception alone can trigger strong reactions.
For example, headlines can shift expectations about future earnings and growth. A company might be operationally sound today, but if investors believe tariffs will crush its profit margins next quarter, they sell now. This intersection of rapid information flow and shifting sentiment means that external shocks don’t just change prices; they change them fast.
Contagion and systemic risk
Sometimes a shock is uncontainable. A problem in one market or sector can quickly spread to others because of the interconnectedness of the global financial system. This spillover effect is called contagion. It happens because global stock markets are linked through funding arrangements, counterparty relationships, and shared risk exposures.
Counterparty risk amplifies this contagion. Banks, hedge funds, and institutional investors all trade with each other. If one party suffers major losses and can’t meet its obligations, others who depend on the latter’s solvency face their own crises.
And contagion can multiply by multiple factors when you rope in volatility and liquidity issues. When fear is high and buyers have disappeared, forced selling in one market depresses prices in others simply because sellers take what they can get, wherever they can get it. This creates a vicious cycle: the shock hits one area, stress forces selling elsewhere, which in turn creates new stress, and the contagion spreads further until either markets stabilize or intervention occurs.
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Written by Sigmanomics Education Team
References:
- CNBC – How Geopolitical Risks Affect the Stock Market
- Bloomberg – Markets React to Natural Disasters and Pandemics
- Reuters – Impact of Cybersecurity Breaches on Stock Prices
- Investopedia – Financial Crises and Their Effects on Markets
- World Economic Forum – How Technology Disruptions Change Markets
