Why Sellers of a Companys Stock are Able to Find Buyers

Prices are Set by Supply and Demand

The stock market is like any other market in that price is determined by supply and demand.

In economics, the Law of Supply states that as the price of an item increases, the supply offered will increase and vice versa, while the Law of Demand states that as the price of a good or service increases the quantity demanded of the good or service will decrease. The price at which the quantity supplied equals the quantity demanded is the equilibrium or market price in that, at this price the amount that people who are buying are willing and able to purchase is equal to the amount that people who are selling are willing and able to produce and offer.

Determining Market Price

If the price of a good or service is above the equilibrium or market price there will be more people offering the product than there are people wanting the product which means that some sellers will end up with unsold product. The only way to sell this "surplus" product is to lower the price.

Similarly, if the good is priced below the equilibrium or market price, consumers will want to buy more than sellers are willing to sell leaving some buyers unable to acquire the product. In order to avoid being one of those who don't get the chance to buy the product, some buyers will offer to pay more than the current price in order to be among those who get the product and this will cause the overall price to move upward toward the equilibrium or market price.

(NOTE: some times this is done indirectly as when a manufacturer aggressively hypes a product but only has limited supplies available initially causing consumers to line up outside stores hours or even days before the product is released. Many of those who show up first for the line and get in the doors first, then try to buy as much of the product as possible intending to immediately re-sell it on eBay or other auction sites at a higher price. Ticket scalping is another example of this as they line up early and buy multiple tickets to a hot event and then try to re-sell the tickets at a higher price to those who show up at the event and find that the ticket window is closed due to having sold-outs).

Supply and Demand for Stocks

So, how does this work with the stock market? To understand how the laws of supply and demand apply to the stock market we have to understand three things:

First, every share of a given company's common stock is exactly like any other share in that class so it makes no difference who one buys the stock from as the shares are all the same.

Second, for stocks of companies listed on the major exchanges of the world, millions of shares have been issued which means that hundreds of thousands of people own some shares of a given company's stock thereby making it difficult, if not impossible, for any one seller to influence the price of that company's stock by their decision to sell or not sell at any given time.

Third, the decision to buy or sell a particular stock is based mainly on the individual buyer's or seller's expectations about the future and how it will affect the value of the stock. If the company is making good profits, paying a good dividend and the expectations are that the profits and dividends will continue at the same rate for the foreseeable future, then buyers seeking income will want to buy it while sellers seeking income will want to hold it.

Others may take a different view and seek not current dividend income but are looking for the value of the company to increase as its profits grow and are reinvested in the company to increase its size and profitability. Again, buyers believing that growth will continue will want to buy the stock while sellers owning the stock and believing the same thing will want to keep it. 

No One, Amateur or Professional, Can Accurately and Consistantly Predict the Future

Obviously if everyone's belief about the future were the same we could potentially have situations where, if the belief that the future prospects were bleak, sellers would want to sell but there would be no buyers while in situations where the belief was that future prospects were good, buyers would want to buy but sellers would not want to sell. However, we must remember that no one can know or predict the future with 100% precision and accuracy.

One only had to watch the stock market programs on CNBC (or other networks or read articles in the print media) while the stock market and other financial markets were crashing and setting new record lows practically every day, during October and November of 2008 to see that even professional economists, both inside government and outside, and financial experts/advisers could not agree on what the future held or provide any consensus as to what investors should do. As the old joke says, bring three economists together in a room and you will get at least six different opinions as to where the economy is going.

If professionals who make their living studying the economy and the market and advising individuals, businesses and governments on what to expect the economy to do in the near future, let alone the long term, how can we expect individuals making buying and selling decisions to share, let alone act on, a uniform view of the future?

Sure, many people do simply follow the crowd and invest the way everyone else is and occasionally a majority does this leading to the market acting like a bubble that keeps continually expanding until it suddenly bursts. We saw this with the famous Tulip Mania ( http://en.wikipedia.org/wiki/Tulip_mania ) in the seventeenth century when tulip bulbs were first introduced in Europe and became so popular and valuable that people brought them, not to plant, but to make a quick profit by quickly reselling them. The bubble finally burst leaving thousands of investors with a bag full of near worthless bulbs that they never intended to plant. The eighteenth century South Sea Bubble ( http://en.wikipedia.org/wiki/South_Sea_Bubble ), the stock market crash of 1929, ( http://en.wikipedia.org/wiki/Wall_Street_Crash_of_1929 ) the Dot Com Bubble ( http://en.wikipedia.org/wiki/Dot-com_bubble ) of the mid-1990s and the recent 2008 housing and stock market crash are all examples of this type of investing mania.

Risk and Reward for Sellers

Expectations about the future and tolerance for risk vary greatly from individual to individual so that, even in the case of the crashes cited above, not everyone lost money when these markets crashed - there were many who either guessed the future correctly and/or sought to avoid undue risk by cashing out early, before the actual crash, and pocketing their profits. None of these people could accurately predict when the crash would happen, they just believed it would happen and, in the process, many of them could have made a much larger profit if they had stayed in a few more days, weeks or even months.

Others, looking through the wreckage following the crash and believing that good times would eventually return, made fortunes by buying the assets and securities that were selling for next to nothing and profited greatly when good times returned and their investments appreciated. In the dark days immediately following the 1929 Stock Market Crash the late Sir John Templeton placed an order to purchase 100 shares of every stock listed on the New York Stock Exchange (there weren't that many listed in those days but the major American corporations were listed there and when, following the Great Depression and World War II, the economy recovered that investment became the foundation of Templeton's fortune. John Templeton not only became wealthy but went on to start the Templeton family of mutual funds (since merged with Franklin Funds and now a part of the Franklin-Templeton Funds family).

In addition to expectations and tolerance for risk varying greatly among individuals, circumstances also vary. A person in their twenties investing for retirement will generally take a longer term view and, regardless of their expectations and tolerance for risk, will tend to view stocks as a better investment for the 30 - 40 year time horizon between now and the individual's planned retirement. On the other hand, a person nearing retirement will want to start converting their stock holdings to something less volatile like bonds or certificates of deposit (CDs) which have little or no price fluctuation, so as to avoid downturns, like the one we are now experiencing, when they have to rely on the funds for retirement. Other factors that also cause people to decide to buy or sell shares despite their tolerance for risk or expectations for the future include a seller's sudden need for money - when they lose a job, face large and unexpected medical or legal bills, etc.

Influences on Buyers of Stock

On the buying side we often find people who suddenly receive a large lump sum of money such as an inheritance, a one time bonus, gain from the sale of a home or other property or whose income suddenly increases. When interest rates on alternative investments (savings accounts, CDs, bonds, etc.) are very low these people often feel compelled to invest some or all of these funds in stocks in order to get some return.

Much of the recent run up in stock prices prior to the crash of 2008 came from workers in third world countries who, thanks to economic growth in recent decades, suddenly found themselves able to save for things like their retirement or their children's education and foreign stock markets were the only place where they could get a return on their money. While Americans and Europeans sent billions of dollars to China and other Third World countries in exchange for manufactured goods, much of the money spent on these goods came right back to the U.S. and Europe in the form of investments.

Given the large number of people in the market and the millions of shares of each company's stock that are available on the major exchanges, coupled with the varying expectations, risk tolerance and needs of the millions of people investing, it is easy to understand why, for companies with millions of shares of stock, it is almost always possible for a person to instruct their broker to sell their shares and have someone else immediately purchase them. In addition to sellers being able to instruct their brokers to sell instantly at the market price, they can also instruct them to sell if the stock rises to a certain price (thereby locking in a profit) and/or sell if the market drops down to that price (thereby limiting their loss).

Buyers have the option of either instructing the broker to buy at the current price (which, depending upon how fast the market is changing and how fast the order is executed, may be more or less than the price the buyer expected when the order was placed) or, if they feel the price will drop, can place an order to buy when the price drops to a specified price. Thus, when a seller instructs a broker to sell their stock and there are no buyers at that price, the broker will look for the next best lower price to try to sell it at that price.

We Influence the Stock Market Even When We Don't Buy or Sell Stocks Directly

Finally you must also remember that individuals can influence the market in other ways besides buying and selling stocks directly. Rather than buying and selling stocks directly, many people instead prefer to invest in a mutual fund and let the funds professional managers do the buying and selling. However, since these individuals are looking security and a good return, they will move their money to another fund if they feel that fund will provide more security and/or a better return. Thus, the money managers are forced to make their decisions to buy and sell based upon the need to provide their customers with the desired level of security and returns.

Also, when people purchase life or property insurance (such as homeowners or car insurance) the company keeps part of the premiums paid in liquid form to pay claims but invests the remainder, much of it in the stock market, in order to have it generate more income which lets them keep their prices low and remain competitive. Insurance companies along with mutual fund companies, pension funds, etc. all participate, along with individual investors, in buying and selling stocks.

Thus, even when the vast majority of people are following the herd and either buying or, as they are now, selling stock, there are enough whose expectations, tolerance for risk and personal needs compel them to act in the opposite direction thereby providing, at some price, a corresponding buyer for every seller and a corresponding seller for every buyer.

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Comments 8 comments

Chuck profile image

Chuck 7 years ago from Tucson, Arizona Author

I think there is a limit to the amount of content a single comment box will save. Here is the sentence that was cut off and the text that followed:

The long run posed a problem only because the U.S. government refuses to allow people to drill for it. We could easily save millions of trees and end global warming by simply exiling every politician, media reporter/commentator and activist that talks and writes about our dependence on foreign oil. Colorado alone has proven reserves equal to those of the entire Middle East. Throw in known reserves in ANWAR, and off our three coasts and we could be exporters rather than importers of oil and this does not include the known reserves in the Canadian Province of Alberta to our north or the potential reserves under the Arctic Ocean (see my Hub http://hubpages.com/politics/A_Very_civil_War_in_t... ). As I explained in my Hub entitled http://hubpages.com/education/How-Markets-Work---T... the run up in oil prices in 2008 was caused by fears that increasing world demand without increases in supply would drive up prices. To protect against this big users of oil - refineries, airlines, etc. began entering into contracts to purchase oil at a future date for a price agreed upon now. As more started doing this, in response to politicians and media running around like Chicken Little blaming China an India for using up the world's oil, both the future and then current price of oil began rising. Obviously if the future price of oil is rising rapidly then people know that they will be facing higher prices soon so they begin to stock up. Those that had storage facilities (farmers, trucking depots, etc.) moved to keep their tanks topped off as each new purchase would cost more while individual drivers, like you and me (me at least) topped off our gas tanks regularly rather than waiting until the tank was nearly empty as the price was rising daily. As soon as former President Bush announced that he was lifting some of the restrictions on offshore drilling the price of oil plummeted as people saw that we would have oil and immediately stopped buying for the future.


issues veritas 7 years ago

Chuck

Thanks for the detailed explanationit looks like you didn't quite finish "dri".

Because of your limited time, I will summarize my response to your points.

While your response work well in academia, the real world facts of today's economy support my contentions.

If things work the way that you described them, then the economy wouldn't have failed.


Chuck profile image

Chuck 7 years ago from Tucson, Arizona Author

issues veritas - Thank you for the clarification.  I didn't take this as personal, but did have some trouble trying to figure out your point, which you have not clarified, in the first paragraph of your original comment.

The fact is that I don't have a lot of time to write as I have a wife and family who I like spend time with in addition to a full time job, a part-time job teaching economics and a part-time business with my wife in addition to writing for HubPages.  While I enjoy writing for HubPages and reading Hubs by others there is just so much time available in a day.  

Most of my writing is done in the morning before work and in the evening when my wife is at work or on occasional days off like today.  For this reason I usually log into HubPages before work and click on the Comments tab to check comments.  Except for obscenities posted by spammers or irrelevant links posted by spammers I click "approve" on all of the comments including those from outsiders who make relevant comments and post a link to their website that covers the same topic.  As to responding I try to respond to most comments but generally do not respond to simple statements, favorable or unfavorable, about the Hub that neither state something upon which I can continue the discussion or answer a question (I do sometimes ignore questions which I have already answered one or more times for earlier commentor's - see my Hubs on How to Become a Fighter Pilot http://hubpages.com/business/How_to_Become_a_Fight...   or How to Become a Commercial Pilot  http://hubpages.com/business/How_to_Become_a_Comme... ).  See my Hubs http://hubpages.com/business/How-to-File-Income-Ta...  or https://pairedlife.com/relationships/Bringing_Your... for examples of such answers which often take as long or longer to research and write as the Hub itself.  I also try to respond to comments which make statements which I feel I can either elaborate on or refute.  My Hub entitled http://hubpages.com/education/How_Tax_Cuts_Work and http://hubpages.com/money/I_Just_Won_the_Lottery have extensive replies to comments by me.

As to the opinions you stated in your previous comment, I apologize for not taking the time to write a response to your other points so here are my responses to those points:

"You forget institutional investments in a company can be huge and when they buy or sell a stock it can have impact."  You are correct in stating that institutional investors actions can have an effect on a company's stock.  However, I believe securities laws and regulations limit the percentage of a company's stock that a mutual fund can purchase without losing its status as a mutual fund and exposing itself to other taxes and regulations.  Also, as I pointed out in the Hub, managers of mutual funds are guided by supply and demand for the shares of their fund since if they don't generate good returns people will take their money and go someplace else.

"Adam Smith's supply and demand doesn't work in a system that have regulations and government interference. The best form of a business is a monopoly, that is if you own the company."  I disagree.  The laws of supply and demand continue to work just not to the benefit of society.  When a government subsidizes something more resources will be diverted to the production of that product resulting in less of other goods as I explained in my Hub http://hubpages.com/politics/The-Politics-of-Ethan where the government's subsidies and laws mandating the use of ethanol resulted in farmers producing more ethanol which people didn't want and reduced corn available for consumption thereby driving up the price of food.  The same is true of price controls in which the low price results in an increase in the quantity demanded (and reduction in quantity supplied) thereby causing a shortage.  As to monopolies, Smith was against them and the only effective ones are those in which the monopolist and his business are backed by the government and the force of law.  Remove government support and the monopoly disappears (the deregulation of telephone service is a perfect example of this). 

"mutual funds and hedge funds influence the price of stocks which results in individual investors following their lead."  This is true to some extent.  In general professionals working full time researching and investing can be expected to do better than someone investing blindly so can it make sense for small investors who lack the time to research and invest full time to follow them. This is the same reason many people on a freeway who see cars slowing down up ahead and cars in the right lane exiting choose to follow those exiting.  Sometimes they are wrong but on more than one occasion I have made it to work on time following these people and exiting the freeway rather than passing the exit and spending the next hour sitting in my car trapped between two exits.

"The cable TV news today is the single most influential source on individual investors. The average individual investor today are blind sheep that sniff the sheep in front of them to follow them wherever they go."  I agree that cable TV is influential.  However, everyone's time is limited and no one has the luxury of having the time to gather every piece of information and analyze it thoroughly while the world stops and waits for them to make their decision.  It is easy to criticize people's actions after the fact.  However, people have to make decisions now with the limited information they have available to them and if cable TV is the cheapest and easiest source of information it makes sense to use it.  Further, if so many people are using that information it must work for enough that the others feel confident in following them by using it.

"The stock market today is loaded with non prudent and inexperienced investors that fall for every Ponzi scheme out there. A prime example of that was the dot com boom to bust. Prudent foundational business investing was thrown away by the greed of getting a stock before it was too expensive to buy. Most of the dot com stocks had less fundamentals than penny stocks."  Again, there is some truth to this observation.  However, all investing is basically a bet on the future as one sees it.  Information available to investors varies in quantity and quality from investor to investor (again, depending upon the time and effort they can afford to get it).  People's motivation and tolerance for risk varies.  Yes there are some outright crooks but you find that in all areas of life and have to learn to be careful.  As to penny stocks and risky investments there are many solid companies whose stock started out in the penny stock category and there were many people and companies that did very well in the dot com era.  Listen to old people in any family talk about their youth and investing and you will hear stories about missing opportunities to invest in stocks that were very inexpensive, of companies making such foolish things as cameras (Kodak), cars (GM, Ford - true all three of these companies are on the ropes now but if you brought their stock early in the 20th century and sold in before the end of the century or even early in this century you could have made a fortune), computers, etc.  Life is full of risk but to keep living and get ahead we have to take risks and, in doing so, sometimes lose.

"In the last two decades, economics have been manipulated. The oil scam of 2008 was purely a speculator driven boom for the oil countries. It also helps that oil is a monopoly, OK several Cartels but they act together globally."  Politicians have always tried to manipulate economics to achieve their ends.  As to the run up in oil prices in 2008 this was a rational response to irresponsible fear mongering and misinformation by politicians and the media.  While it is true that rising demand by growing economies of countries like China and India there was enough oil available on the market in the short run to accommodate the growing demand. The long run posed a problem only because the U.S. government refuses to allow people to dri


issues veritas 7 years ago

Chuck

This is not personal, I am just commenting on your hub.

My first paragraph was my diappointment that you didn't respond to the two comments.

The rest of my paragraphs are not responded to by your comment to me.

I was adding to you hub with them.


Chuck profile image

Chuck 7 years ago from Tucson, Arizona Author

issues veritas - Thanks for your comment.

I don't really know what you are trying to say in your first paragraph. Two people before you made a couple of nice comments in which I appreciated their compliments on the Hub and agreed with their opinions.

As to the remaining paragraphs, these are your opinions which I don't for the most part agree with, but respect your right to speak them.

As to believing what I wrote in this Hub, all I can say is that I am a believer in the Free Market and have found nothing in my study of economics to that would cause me to believe differently.

This Hub was written in response to a request from another Hubber and in writing it I tried to answer the request in as clear and accurate manner as possible. While it is true that government regulation causes distortions in the market as on occasion does the actions of powerful players in individual markets, the market does adjust and evens out these distortions in the long run.


issues veritas 7 years ago

Chuck

I see that  you don't even believe what you write. No responses even to your own hub.

You forget institutional investments in a company can be huge and when they buy or sell a stock it can have impact.

Adam Smith's supply and demand doesn't work in a system that have regulations and government interference. The best form of a business is a monopoly, that is if you own the company.

mutual funds and hedge funds influence the price of stocks which results in individual investors following their lead.

The cable TV news today is the single most influential source on individual investors. The average individual investor today are blind sheep that sniff the sheep in front of them to follow them wherever they go.

The stock market today is loaded with non prudent and inexperienced investors that fall for every Ponzi scheme out there. A prime exampe of that was the dot com boom to bust. Prudent foundational business investing was thrown away by the greed of getting a stock before it was too expensive to buy. Most of the dot com stocks had less fundamentals than penny stocks.

In the last two decades, economics have been manipulated. The oil scam of 2008 was purely a speculator driven boom for the oil countries. It also helps that oil is a monopoly, OK several Cartels but they act together globally.

 


mulberry1 profile image

mulberry1 7 years ago

Yes, good information. They always stress that you should invest in things you don't understand...unfortunately for many people that means they wouldn't invest in anything at all. Guess they should incorporate more of the basic economics and understanding of the stock market in the high school curriculum.


jkfrancis profile image

jkfrancis 7 years ago

Chuck,

One of the best and most succint explanations of markets, supply/demand and risk/rewards and how they interact I've read!

Everyone should read this because it's essential to know not only how the markets work, but the influence it has on our country works, indeed the world.

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