Good morning, happy Monday, and happy Cinco de Mayo!
“For most investors: 99% of good investing is doing nothing, the other 1% is how you behave when the world is going crazy.”
– Morgan Housel, author of Psychology of Money
I think the majority of us understand that stocks go up and stocks go down, but I have found that many of us don’t really understand why.
What causes the market to go up or down? Are there ways of predicting when the market is going to go in one direction or another? Who decides if stocks go up or down?
These are the questions I will attempt to answer today.
I’ll address that last question first: who decides if stocks go up or down? The answer to that is all collective investors. Here’s what happens …
When the stock market opens every day all the publicly traded stocks are available to be bought and sold by the public. Then the forces of supply and demand come into play to determine the price of the stock and the value of the company.
What does every investor want?
It’s quite simple: they want to make money, and as much as possible. This is the universal objective of investing. It’s why you invest and why I invest.
The stock market and every company are quite simply a human institution. They are owned by humans, they are run by humans, and they are designed to benefit humans. It’s so easy to think of “greedy Wall Street” as a collective without human connection, but that is simply not the case. These companies are run and managed by some of the smartest people ever to walk the earth. And they show up every day to make their companies as profitable as possible. They are run by people for the benefit of people, both their customers and their owners.
As we’ve discussed many times, when you buy a stock, you are an owner of a company.
Let’s just pretend for a moment that Intentional Wealth were a publicly traded company (which it is not) and that the value of the company is $10 million (which it is not … but I can dream 😉). Furthermore, let’s say that there are 100,000 shares of stock in the company, which would mean that each share of stock would have a value of $100. ($100 per share x 100,000 shares = $10 million value).
Ok, so the stock value of Intentional Wealth is $10 per share in this hypothetical example. Then at 9:30am on Monday morning the stock market opens and anyone who wants to can purchase shares of Intentional Wealth. Also, anyone who owns shares of Intentional Wealth can sell them.
Who are buyers buying these shares from? Who are sellers selling to?
It’s actually quite simple: the buyers are buying from the sellers, and the sellers are selling to the buyers.
If today you call me and say, “Pull $10,000 from my bank account and put it into my investment account,” you would be a buyer of stocks. Alternatively, if you call and say, “I need $10,000 for a specific purpose, please sell $10,000 from my investment account and deposit it into my bank account,” then you would be a stock seller.
So, from 9:30am-4:00pm EST Monday-Friday (except holidays) buyers and sellers are meeting to initiate transactions. This is where the price is determined.
Continuing with the Intentional Wealth example: let’s say that you own 1,000 shares of stock in the company (representing $100,000 in value at $10 a share) and you need $10,000 to go on a vacation. You would then go into the market with a sell order for 100 shares. The market would then match your 100 shares sell order with a buyer who is willing to pay $10 per share for 100 shares.
If there is buyer willing to pay $10.25 per share, you as the seller would be very pleased by that … selling 100 shares would result in $10,250 in proceeds instead of $10,000. But if there are no buyers at $10 per share you would have to reduce the price to the point in which there are buyers. Let’s say the highest price point a buyer is willing to pay is $9.75 then you as the seller will have to determine if you are willing to sell at that price … if yes, then you get $9,750 for the sale of those 100 shares.
So, every day the stock market is open, buyers and sellers are meeting to transact business … and the price is where the two parties meet. The price of the stock is determined in that moment by what a buyer is willing to pay and what a seller is willing to sell.
This happens at lightning speed and at a very high volumes. As an example, Friday (May 2nd) Apple’s stock volume was 86,358,107 shares at a price point of around $203. That’ means that in that single day buyers and sellers transacted roughly $17.5 billion in Apple stock alone. That means in this one day over 13 million shares traded hands each hour … that’s over 221,000 shares per minute … roughly 3,690 shares per second. Lots of buying and selling, lots of buyers and sellers.
So, if you call me today and say, “Add $10,000 to my investment account and purchase stocks,” then I’m going to place the order for you and your order will be matched with sellers selling those same investments. The price we paid as buyers would be what the market dictated based on fellow investors selling those same investments.
As a general rule, when there are more buyers than sellers stocks will go up. Conversely, when there are more sellers than buyers stock prices will go down.
In the stock market there is a general rule that there is always a buyer and there is always a seller, it’s just a matter of the price point. This is true in real life for all of us as well.
If I’m not in the market for a car, but I see a brand new Lexus for $1,000 I would buy it even if I don’t need it. It’s just too good of a deal to pass up.
At the exact same time, if someone were to offer me $100,000 for my Toyota Camry I would take that deal. It’s just too good of a deal to pass up.
Investors in the stock market are doing the same thing. If I’m not looking to be a buyer but a stock is super cheap, then I will buy it because I feel I can’t pass up the deal. If I like the stocks I hold and am not looking to sell, but I can turn a $100,000 investment into a $1,000,000 investment I will be very tempted to sell because I feel like I can’t pass up the deal.
The buyer is buying because they believe it is a profitable thing to do. The seller is selling because they believe that is the profitable thing to do. Where the two meet is where the price point is set. And that changes from moment to moment based on a ton of factors … many of the main ones being company specific information, industry specific news, and general economic conditions.
One last example as I know I’m getting a bit long winded here (I know you are shocked 😉).
Let’s revisit the hypothetical example of Intentional Wealth being a publicly traded company. If the general economic conditions are looking very favorable, all factors equal, investors would pay more for stock in my company. If economic conditions looked gloomy investors would be willing to pay less. When COVID-19 first came on the scene it didn’t matter how good a business was, the value was dropping because of the overall economic conditions.
If there were industry news that was positive, say my competitors reported huge profit increases, then investors would likely pay more for Intentional Wealth stock ownership with the thoughts that the industry is increasing in profitability. Same vice versa. This is where you may see a sizable movement in stock price for a company when there was no news about that company at all. If Pepsi reports huge sale increases, you likely will see Coke stock go up because investors feel the market is very favorable for that industry as a whole.
Then there are company specific events that move stock. If I were to announce that I’m bringing on a big name business partner (which I’m not) then the stock of Intentional Wealth (which again does not exist) would likely increase dramatically. Investors would likely think this move could drive up the future profitability of the company and they would be willing to pay more for an ownership stake in the company. If I reported some type of bad news, you would see the stock value drop. The perfect recent example of this is Tesla. With Elon Musk taking on a politically involved role with the Trump administration and DOGE we saw Tesla stock drop dramatically (not the only factor, but likely the primary one).
For the sake of time, I will address the predictability of stock movements in a future memo, likely next week. A fascinating topic (at least to me 😉)
But I do hope this explanation makes sense and helps to further your understanding of how the stock market works.
As always, if you have any questions or ways we can support you, please never hesitate to reach out. We are always thrilled to talk with our amazing clients!
Make it a great week ahead.