Friday, February 13, 2009

Supply and Demand

It took me a while to think of the markets in this way, but it's all they are: a great big playground for supply and demand. I don't know if the stock you are buying has any intrinsic worth. You're not able to trade it in for a spiffy office chair or a portion of Microsoft's Windows source code. While I understand that a company could eventually be bought out, thus giving you a chance for a guaranteed price on your shares, I don't see this happening very frequently at all. And should a company go bankrupt, the common shareholders tend to get diddly squat; bondholders are given first dibs on property.

When you see a stock priced at a certain value, remember it is at that value because people are willing to pay for it at that value. At the moment, yes, it may have some intrinsic worth. You own a part of the company and, depending on the stock, you may even get a portion of their earnings. But what happens to that share in time? I would argue that every company submits to entropy.

In any case, if you were to learn any one thing, I would suggest you learn how to trade based on supply and demand. That means, basically, trading through charts. If there's buying pushing the stock up, ride it up until the buying begins to dwindle.

Today I was watching bid and ask sizes. Bid sizes indicate how much of a stock the buyers want. From what I have seen (and from my intuitive understanding of supply and demand) if this size is bigger than the ask sizes, then the price eventually goes up. Same thing works in reverse.

Don't get me wrong, fundamentals are necessary. Who's going to buy a company that has no growth possibilities and doesn't sell anything? Just remember that the price is determined by what people are willing to pay and willing to accept. And if you're trading, understanding this will get you onto the right side of the market.

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