This tutorial prepared by the Investment Industry Regulation Organization of Canada (IIROC) is a great introduction as to how stocks are actually traded:
Category: Beginner Investors
How Stocks Work – A Video
Even though this video is very old, it is an amazing “investment” of your time to watch it. It’s an old cartoon of how the New York Stock Exchange works.
Know your customers and your competition
It almost seems so obvious that businesses should know who their customers are. In the real world, many small businesses can get to know their customers’ buying habits and taste, and they even might get to be on a first name basis with them. As companies get bigger, they don’t see customers per se, they see statistics about their customers, such as what gender they are, where they live, what kinds of products are they buying and at what times. Big or small, it pays to know who your customers are and what they want so that, as a great trader (read: middle man or middle woman), you can more effectively exchange your goods for your customer’s cash. An interesting ‘quirk’ of the stock market is that your customer can also be your competitor.
Even though knowing exactly who your customer is just as crucial for the do-it-yourself investor as it is for any other business, the reality of online trading makes this infinitely more challenging. Your “customers” are just numbers and letters on a screen. You have no idea on who they are or what their buying habits are. All you really see are share prices either rising or falling, and from there you can infer that there is either increasing interest in a stock or decreasing interest at any particular price on any given day. And as unsatisfying as that is, millions of people around the world base their stock trading decisions simply on what they are inferring from movements in stock prices. What separates the great traders from the rest of the herd is the understanding what their customers are looking for.
Sugar and Spice, and Everything Price, That’s What Markets are Made of
Most people know of a co-worker, a friend or even a family member who is actively involved in the stock market – maybe that person “made a killing” or “lost their shirt”. The greatest feature of the stock market is also its greatest hazard: namely that anyone with capital can participate. One of the biggest advantages that great traders have over beginners is that great traders understand that a market is actually an arena of opinions and beliefs.
In this article, we want to expand upon the idea of markets as competitive arenas. Specifically we want to show you that when thinking about trading, it is very important to understand that price is just a reflection of beliefs about a particular stock.
Pick a price, any price
In one of our previous articles, we described the market as a “price discovery mechanism” – that is, through the actions of buyers and sellers of a good (in this case a stock), the market price of that good can be established. In the highly complex world that we now find ourselves in, money – or more accurately purchasing power, is critical to keeping the world going. Having a mechanism to ensure we know how much ‘things’ are worth is absolutely essential to allow people to exchange the right amount of money for those things.
When you see a price quoted for a stock, it is actually slightly misleading in the sense that it leads you to believe that a stock has only one price, when in fact the price for a stock could be one of three prices. In stock trading language, the price a buyer wants to buy at is known as the “bid price”; the price a seller wants to sell at is known as the “ask price” and the price they ultimately settle on is known as the “last price”. It is the “last price” that is often quoted as the “market price”.
An Intro to Markets
What makes a market?
If there’s one thing that you can guarantee about the stock market, it’s that everyone has an opinion. At first blush, it seems fairly obvious that with so many different people participating in the market, there’s bound to be differences of opinion.
What many observers and inexperienced investors/traders don’t do, however, is to look deeper at what it is they’re actually saying by admitting that there are so many different opinions. By acknowledging the differences of opinion in the market, the most profound insight is that not everyone can be right at the same time. In other words, somebody has to be right and somebody has to be wrong. It is this very disagreement, in fact, that makes a market.
Two’s company but three’s a market?
So why is this seemingly trivial piece of information actually incredibly valuable? To understand why, we have to take a step back and understand first where a “market” comes from.
Simply put, a market arises because a buyer wants to buy something and a seller wants to sell something. Where they have to come to some agreement on is price. It is for that reason that markets are sometimes referred to as “price discovery mechanisms”. One of the favourite questions Sparx encourages beginner traders to ask is: “how much is something worth?” Think about that for just a moment. The answer is “whatever someone is willing to pay for it”. Without both a buyer AND a seller, there is NO market.
Markets are born out of disagreement; they are built on one party believing one thing and another believing the exact opposite. For this reason, buyers and sellers compete directly with one another in what some call a “zero-sum” game meaning that the “winner” wins at the expense of the “loser”. While this is mostly true, there are also slews of “middle men” or brokers that facilitate buyers and sellers’ transactions (more on that in another article).
A convenient way to think about trading
A convenient way of thinking about trading
Most people believe that in order to be successful in business, you have to be profitable, and for the most part they’d be right. The primary “goal” is quite easy to measure – are you profitable or are you not? If you talk to any salesperson or sit through any company sales pitch, however, you may hear a different depiction of what businesses are. Namely they are “problem solvers”.
Whichever way you characterize it, businesses exist to supply products or services for those that demand (either want or need) particular products and services. It is helpful to point this out because if you decide you want to trade, it is much more practical to think of trading as one would if they were opening/operating their own business. If you were to think of stock trading as a business you might start to ask: what type of business am I? Who are my customers? Who are my competitors? Who are my collaborators? What kind of market is there for my product/service? If you are trading a stock, though, what “problem” are you solving?
One very useful way to think about trading stocks is by way of an analogy with a convenience store. The convenience store is in the business of having everyday items available in a convenient location. Customers usually pay a bit of a premium for the “convenience” of not having to go out of their way to get the desired item. As a stock trader or investor, you are a convenient source of an item (stocks) that may be in demand. You solve the problem of inconvenient access to a stock for a buyer or seller.