example, “buyers stayed away in droves” rationalizes a down market. Such
expressions are used, including by us in this book, as if there can be an
uneven number of buyers and sellers and it is this factor that drives stock
prices up or down. In reality, the number of buyers and sellers of a stock
is always exactly equal, as there can be no sale or purchase without both
a buyer and a seller. What is actually at work is a balancing of supply and
demand through the mechanism of price. In a smoothly functioning market
economy the prices of everything bought and sold are governed by supply
and demand. So it is too with the stock market. Companies issue a limited
number of shares, so when this finite number is then subsequently traded
on a stock exchange, the level of supply in that particular stock on any
particular day is constant and unchanging. It is the level of demand for the
stock that fluctuates, however, and the dynamic by which the fixed supply
and the shifting demand are kept constantly in a state of equilibrium is
through the mechanism of price.
This raises the question of what it is exactly that causes the price of
any given stock to fluctuate fairly strongly, as most do each and every day.
The theoretical cause of the changes in demand for a stock during the trading
day is that demand is raised by increased expectations regarding the
prospects for the stock and decreased by dampened expectations. However,
if this were all that were going on, one would expect to see very little
change in most stocks’ prices from day to day or during the course of any
trading day, except for those for which quarterly numbers are reported or
other specific company news is released. But most stock prices actually do
move around quite vigorously, moving up and down and bouncing around
each and every trading day. Clearly something else is going on here. The
demand for individual stocks as well as the demand for stocks as a group
forming the overall market are both driven by a constant struggle among
all investors, both professional and amateur, involving the two major emotions
that affect people’s investing and trading habits—greed and fear. The
combined effects of the interplay between greed and fear in investors’ and
traders’ emotions drive the demand for and thereby the pricing of each individual
stock up and down, constantly throughout the day. Interestingly
as stock prices are affected by the prevailing currents of optimism and
gloom that wash constantly over the market, as a result the vast majority
of stocks exhibit price movements that are remarkably similar to each
other’s. The overall market too, as measured by market indices, exhibits
exactly the same movements up and down that characterize the majority
of individual stocks, and this is as would be expected as the overall
market is nothing more than a grouping of those stocks. However, we feel
that it is too simplistic to conclude that the direct connection of individual
stock prices to overall market movements is a one-way street. The truth is
more nuanced. In fact, as traders and investors watch the overall market
as much if not more than they do the prices of any individual stocks, it is
their perception of what is happening to the Dow that affects dramatically
their view as to whether they should be buying or selling individual stock
positions. It can be the subject of some debate here which is the chicken,
which the egg in this subtle cause and effect conundrum. Regardless, we
believe that it is the constant change of sentiment in the investment community,
lurching from positive to negative and back again regarding the
outlook for stocks, reinforced with data read from the Dow Jones Industrial
Average Index that actually spurs the majority of individual stock buys
and sells. It is this that drives the market even more than individual stock
price fluctuations caused by stock-specific news. Related to this point, it is
interesting how the market often has difficulty passing through important
psychological milestones such as the round number 1,000 markers—Dow
10,000, 11,000, 12,000, and so on. It is clear that investors become more
excited and nervous around these levels and trading is affected accordingly.
Clearly this has nothing to do with company fundamentals, news,
interest rate trends, economic and political developments, and the like. It
is an indication that the market index value—and essentially that of the
Dow Jones Industrial Average—is one of the prime influencing factors on
whether investors/traders are in the mood to jump in and buy or seek to
sell individual stocks.
Although the laws of supply and demand cause an ebb and flow in
stock market prices in the same way as they affect pricing in any other
kind of human economic activity, it is interesting to note that the stock
market is the only place where people are actually happier buying when
prices go up and are reluctant to buy when prices go down. It is really a
strange phenomenon. Can you imagine hordes of people arriving at a shopping
mall the day after Thanksgiving when many retailers lure shoppers by
marking down their prices, and being disappointed at the bargains? Would
it not surprise you to see all these would-be customers returning to the
parking lot upset and empty-handed and with the intention of coming back
when prices have risen again? Sounds crazy, doesn’t it? In the stock market,
down days represent those days on which stocks go on sale. By definition,
they are also days on which there is a greater reluctance to buy stocks.
Up days in the market, on the other hand, are naturally days in which
most individual stock prices are also up, and ironically, they are the days
that buyers start to salivate and open their wallets. Investors and traders
are buying up a storm, and the pricing power is back in the hands of the
seller. It is a classic case of crowd mentality at work—people are buying
because others are buying. But this is clearly illogical because it means that
investors/traders are as a rule happier paying higher prices. As Warren Buffett
once cannily put it, “You pay a very high price in the stock market for a
cheery consensus.”
As has been mentioned earlier in this book, it is interesting that many
writers on investment topics happily use the general upward rise over
the years of the Dow Jones Industrial Average to prove to their readers
the wisdom of buying and holding individual stocks over time. Yet, when
these same experts turn to individual stocks, they tend to proffer advice
on the buying and selling of these as if all that moves stocks are their own
internal dynamics as a stock and as a company. As noted, we strongly
believe that it is the direction of market movements on any given day or
even longer term, that actually provides the most fundamental driver of
individual stock price movements, whether their direction is up or down.
It is no coincidence that the short-term fluctuations we perceive and take
advantage of in individual stock prices mirror so closely those in the
overall market—they are to all intents and purposes the same fluctuations.
Just to emphasize the important point that we make here, the main
driver of any individual stock’s price movement is the movement of the
overall market. As the overall market fluctuates constantly, with a day or
two of a rising market followed by a day or two of a falling market being
the norm, so too do the prices of individual stocks fluctuate in very similar
patterns. It follows from this that a buyer of a stock has a choice. He can
either buy at a relatively cheaper level on a day and at a time that both the
overall market, as well as the stock he is purchasing, are down in price,
or he can do the opposite, buying at a relatively more expensive level on
a day and at a time that both the market and the stock are relatively more
expensive than they were just hours or days before. We prefer to aim for
the former course of action.
Read More : Supply And Demand
