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.
More by this Author
In a previous Hub (see "How Tax Cuts Work") I discussed how a supply side tax cut works. For the past quarter of a century tax cuts have been synonymous with supply side economic theory and Republican...
- EDITOR'S CHOICE36
Financial leverage is the process by which investors and speculators attempt to increase the return on an investment by the addition of borrowed funds to their investments.
- EDITOR'S CHOICE234
With so many Americans traveling and working abroad to say nothing of meeting people via the Internet, it is not surprising that many are finding love and marrying someone from abroad. Here is how to legally bring your...