How the Stock Market Works(shashankr.me) |
How the Stock Market Works(shashankr.me) |
Then there are the inaccuracies. Zero-sum game? No. Derivatives are "a bet on the rate of change" in value? No. Brokers "help you execute a trade at the best possible price"? Well... not really. The NYSE is a "one stop shop" for people who want to trade? Um, NASDAQ? Any number of non-US exchanges?
Overall, very disappointing.
It seems like an earnest effort by the author. I'd encourage them to find a pro to run this piece by as a further learning experience. When you stop getting edits, you are ready to teach a simplified version to others!
> This is Part 1 of a series. I am not claiming to be an expert by any means, this is just an effort for me to internalize things I’ve learnt.
No. That is just completely wrong. A derivative is a financial instrument that derives value from other things.
As an aside, the derivatives market is far bigger than the stock market.
The investable universe looks something like that:
> derivative in finance is a bet on the rate of change of the value of a stock
No. At least no more than an equity is also based on the change in value of the company. At best it is just a terrible way to describe it. It is a derivative because it derives it's value from the underlying. You can get rid of the "rate" part and it would be more correct.
> The New York Stock Exchange is a company that maintains a database that is a one-stop shop for people who want to trade stocks and other fancy financial instruments.
Don't even know where to begin with how misleading that is.
> that is a reflection of a section of the stock market performing “well”, in the sense of investors making money4 on their stock investments.
Not really. It is the value of the companies going up. I'm sure many are losing money too in both a real sense and a "I shouldn't have have sold" opportunity cost regret.
> Depending on what the Fed’s interest rate is, you could conceivably buy a bond off of somebody for lesser than the principal.
Nope. The feds target overnight rate has very little to do with how bonds outside the very short end, and nothing to do with the long end most people would be buying.
> It’s a zero-sum game, because there are always winners and losers in the stock market.
Not really. While each individual trade is zero sum, the collection of them creates more efficient capital flows and helps they health of the market in a very general sense. Without the traders, the market would dry up and nobody would make any money from it.
Is this true, outside of options? Most people are long and the stock market has always been on an uptrend.
Is the market peaking? With so many clueless entering the market. Where would be the next herd of new blood?
You have 100% at any given point, where does it go? Not buying anything is going 100% cash. That's why you have to do it - you're always in some exposure.
Then you can always lever up securities, effectively going negative on cash. Example: 105% stocks, 195% long term bonds, -200% cash can be achieved by going 35% UPRO, 65% TLT; only for the brave souls among us that do not fear a 300% leverage. This is roughly how the Bridgewater All-Weather Fund operates (AFAIK you can choose your leverage level there).
Many households are quite levered up by getting a mortgage. A mortgage with downpayment of 20% results in 1/0.2 = 500% leveraged exposure to the real estate market (slowly declining over time as the principal is paid, or if the house appreciates in value).
However, many of the ideas are misunderstood. A couple months of playing around with a stock trading app and maybe reading some blog posts will not teach you what markets are or why they exist.
For quite some time, a significant amount of brain power has gone into understanding and improving markets. All of this work has resulted in significant complexity.
If I had to pick a place to start, were I to teach someone "Everything they ever wanted to know about the stock market," It would actually be with bonds. Lending money has been around for millennia. It is an amazingly simple, yet incredibly useful, idea. It's also extremely useful as a way of teaching someone about equity. Bonds and equities are intricately linked in their development and in the theory of valuation.
Not really. Yes, there are winners and losers, but my win doesn’t equate your loss.
Does anyone have a source that actually begins to explain thi stuff? I want something that goes into long/short, that begins to take a stab (in simple terms) at how to analyse a company's finances to identify red flags, or reasons why investing might be a good idea.
You get income than the interest from your bank this way. While in EU you get guaranteed 100.000 EUR when a bank collapses, but if shit really hits the fan (crisis, many companies collapsing, EUR or USD losing a lot of value) you are toasted regardless.
However, he may be talking about pure trading, a.k.a speculation, which is very close to a zero-sum game. If you are not in for the dividends, yes, that's close to a casino where the banks who charge for transactions are the inevitable winners.
I wish we followed Warren Buffet's advice and forbid to sell a stock less than 6 month after buying it. I also don't see any interest in making the stock prices change every nano second. A quote a day can be enough if you are an investor, not a speculator.
Well, there isn't any interest in it per se, but that is intrinsic to how fast we can make trades... Somebody offers the lowest sell price and somebody offers the highest buy price. The "value" constantly changes as those two highs and lows fluctuate based on who decides they'll sell for lower than the lowest offer or who decides they will buy for higher than the highest bid.
Unless you're saying that those offers/bids should only be accepted once/day and can't be changed until the next day? That's the only way I could forsee changing the quote once/day.
Do you know if the share of real GDP for the bottom 10% (or in general, bottom x%) of consumers grown? And is there a well-known term/metric for this?
Regardless, if someone does bid up the price of onions, it will typically trigger increased production of onions as farmers can make more profit by growing onions vs. another vegetable. This increased supply will pull the price back down.
Fun fact: over 60% of the trade volume on the stock markets comes from bots. If you have enough of a superiority illusion to think your daytrading game these days can outplay the MIT PH.D Quant traders that wrote HFT bots for hedge funds, then you're in for a surprise.
I don't have the exact Peter Lynch quote but he said something to the effect that any period of less than two years in the stock market and you're basically entering a casino. Any period of greater than 2 years and you're investing.
Some other investor said that you should give a company enough time to use and generate a return from the money it received from selling it's stock before you fundamentally expect to see the returns.
For any kind of asset, the ability to transfer it has value. When someone needs to buy a new car, they often sell their old car to a dealer at a price that is lower than what they could get if they sold it to another individual. They do it because it is more convenient and/or they can't wait around for the right buyer to come along. A dealer has a better idea of the car's value and is willing to put it into inventory until someone buys it at a higher price. He takes a risk he might have to wait longer than expected to sell it again (which incurs more inventory cost), but he trades a lot of cars, so on average, his relative risk is lower than yours would be. He essentially charges you a fair price for this service. Even though technically you might say you lost on the deal, both sides are winners if the price was reasonable.
In a similar way, a stock trade can be a win-win situation. One trader may be willing to do the transaction at a discount because they have a better way to use the money or because they need to reduce their risk. Another trader may know more about the stock and/or have a different risk profile, so he is willing to take the risk of holding the asset until a profitable transaction is possible. This provides a win-win for both sides if the charge for the service is reasonable.
Of course, there are traders who are detrimental to a market and provide no value, just as there are crooked car dealers. That doesn't invalidate the value of good trading just as it doesn't invalidate the value of good car dealing.
E.g. you could give someone insurance on their stock position if you can take the risk. This allows them to participate in the game so you both benefit.
Another is that you might be able to lend more cheaply than the other can loan but they want to leverage up their portfolio. With options you can effectively make a cheaper loan to them to purchase a specific product. They lend more cheaply, you make part of the spread.
Stocks are not a zero-sum game. They have sustained value, so when I sell you a share of stock, you get the share, and I get money equal to the value of the stock.
One might argue that day trading is roughly a zero-sum game, if we make the simplifying but inaccurate assumption that the values of stocks don’t change across a trading session, and assuming that everyone goes home each night with all positions closed out.
Shares don't give dividends. Companies give dividends. Shares are just how they work out who to give the money to.
It can get a little more complicated than that though -- you might be trying to sell 1000 shares and the highest bid might only be for a quantity of 500 so the "market" price for your first 500 shares will be different than the next 500 (unless there are other bids at that same price, which there often are but there's no guarantee on the volume you'll be able to sell at that price).
And that's why they call it a stock exchange... it's just a bunch of people (and companies) making bids and offers to "exchange" stocks at difference prices. When a buyer and a sell agree on a price, you have a transaction (trade). Your offer to sell at market price is just an agreement between you and someone else willing to buy at that price.
You could also do what they do. Instead of buying immediately at market price, you could enter a lower price and create a standing order to buy at that price. However, if the price goes up, you might miss out on buying the stock at all.
Similarly for selling. You can enter a higher price, but it won't sell if the market price doesn't go up.
Conceptually this isn't so different from what a grocery store does. They offer something for sale and wait for a buyer willing to pay that price. However, margins are much lower and prices change much quicker for stocks.
(Note: I'm not recommending messing with any of this.)
Buying at market price simply means you immediately buy from the seller offering the lowest price.
It's very rare for an order book to be empty for a particular stock, but you typically do see the bid/ask spread increase as a stock loses popularity.
Regulation NMS
https://dqydj.com/sp-500-return-calculator/
Dividends make a massive difference. It's in fact not a secondary but a primary driver of long term profit.
Send orders all day, clear them once a day. Calculate the resulting quote.
Let go of the illusion that the real value of companies change every nano second. The fact that stock exchanges close at night and that for 12 hours, values don't change proves that it is not a necessity.
Having 12 hours instead than a few seconds to think about the impact of a given news on the stock market is going to give room to breath for actual investors.
And in the credit market - after all the good debtors are served, and there's still demand for new credit - bad debtors start being served. This keeps on going till it bursts (like in the housing bubble).
I'd just look at it in a slightly different, perhaps more optimistic way. The fact that this investment has the highest ROI means that society as a whole would benefit from injecting additional capital into that investment.
In that sense, you're right that other investors have a less desirable price. However in theory at least, everyone is better off since that investment now has more capital, and is able to produce more output, positively contributing to the overall economy and increasing the size of the overall pie.