Website owner: James Miller
How does one best understand the stock market? What is the
basic mechanism that determines the prices of stocks? That old
economic law: the law of supply and demand. This is the basic,
underlying law. What causes demand? Mostly things like
investor optimism, confidence, general belief in stocks,
investor exuberance, and the availability of money. And greed,
the attraction of making easy money. What things cause the
lack of demand? Pessimism, disillusionment, lack of confidence
in stocks. And fear. And panic. The stock market is a public
auction and the best way to understand it is to remember this.
The mechanism that determines the prices paid is that of any
auction --- the law of supply and demand. Whether we are
speaking of auctioning horses, paintings, stocks, or whatever,
if there is a huge crowd of enthusiastic bidders, all
outbidding each other for something (i.e. the demand is great),
the price goes up; and if there are few bidders and demand is
small, the price drops. If everyone is in a mood to buy prices
go up and if few are in a mood to buy prices drop. And if
everyone is in a panic to sell, and no-one wants to buy, prices
drop precipitously.
Some good, descriptive language of the stock market is phrased
in words like "bubbles" and "collapses". Soap bubbles look big
and beautiful and then, without warning, they suddenly pop and
vanish; what was big, beautiful and substantive is suddenly
nothing. People with all their life savings in stocks can
suddenly see those savings disappear in a stock market crash --
like a bursting soap bubble. The stock market is about
developing bubbles and bursting bubbles, stock price inflation
and stock price deflation.
How about the techniques of stock fundamental analysis and the
attempt to find "value" in stocks and pick them on that basis?
I think it is mostly psychological factors, and the way these
factors influence demand, that determines how stocks perform.
And, if this is true, playing the stock market is very much a
game of chance and risk, a gambler's game, much akin to betting
on horses.
May 2000
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