Wednesday, November 05, 2008

Investing 101 - How the Markets Work....

This is one of my biggest pet peeves. The argument that stocks will go higher b/c more money will have to be "put to work" or "come off the sidelines". Every talking head on TV keeps referring to all of the money in money market funds, etc.

If I have $100 sitting in my etrade account and I decide to buy 10 shares of xyz for $10/share, my money has come off the sideline, but what about the other side of the transaction? Someone just sold me 10 shares of XYZ at $10 and now has $100 of cash sitting on the sidelines in their account.

This is the most basic tenet of the stock market there are always buyers and sellers (with the exception of IPOs that take new cash into the market), but 98% of professionals don't understand this concept.

The markets will be focused on the jobs number tomorrow. I'm not a tinfoil hat guy, but watch the birth/death adjustment tomorrow, it might really make for a wacky number.

Cheers!

1 comment:

Anonymous said...

I'm sorry but your argument is simplistic too. If half of market participants leave the market, isn't that affecting market prices? Isn't that the whole idea behind forced fund redemptions causing the crash? So if same/similar money comes back in you're saying that the opposite effect doesn't work?

"A buyer for every seller" is also very simplistic. That's why we have market makers. 10,000 people leaving the market and selling their stock to the market maker is a vastly different outlook than 10,000 people selling to 10,000 other genuine long-term buyers. Genuine long-term buyers will lock away the stock so it's no longer available for purchase in the short term future, but the market maker hates to bloat his book with any single stock and would gladly get rid of the excess and reduce the ask if he needs to. It's a world of difference, even if there's "a buyer for every seller". The market maker is more a forced buyer than a willing participant here.