Post by oldman on Oct 19, 2013 7:22:48 GMT 7
Your First Million, 2nd Edition
Chapter 2 - The Battlefield
We all have a tendency to try to find reasons why a stock goes up or down. Humans created technical analysis and fundamental analysis to try and plant reasons in share price movements. Newspapers and brokers write daily commentaries, which give the impression that they know more than us. The reality, though, is that the movement of stocks and shares is based on simple demand and supply. The unique thing about stocks and shares is that the number issued is finite. In other words, supply is limited. On the other hand, demand for these shares can be unlimited. This is in sharp contrast to futures where both supply and demand are theoretically unlimited. It is for this reason that I don’t trade in futures, as the strategy for futures is unlikely to be the same for stocks and shares.
What this means is that if supply is sucked up for whatever reason, even though the demand remains the same, the share price is likely to go up. The supply can be sucked up in a number of ways. If there is a strategic investor who keeps mopping up the supply from the open market, the number of shares available will be reduced. If however, the strategic investor is just taking a placement of new shares by the company, then this is unlikely to affect the number of shares floating around.
If the company buys back its own shares from the open market, the same phenomenon will also happen. The supply is being sucked up, resulting in less shares floating around.
This is why the game of stocks and shares is skewed towards players with deeper pockets. They can affect the supply more than a typical retail investor.
Theoretically, there is no art or science here. It is simply a matter of having the financial muscle to buy up enough shares to reduce the available float. Even the largest counter in the Singapore Exchange is small by US standards. Hence, every counter will be at the mercy of the laws of demand and supply.
With IPO stocks, the major shareholders are usually under moratorium for six months to a year, meaning that they will not be able to sell their shares during these post-IPO periods. As a result, the free float during these periods will be limited to the number of IPO shares offered for sale. In many cases, this may amount to just 20% of the total number of shares. As supply is limited during these six months to a year, the post-IPO stock price can rise sharply if demand is high. But when the moratorium is over, there will be a lot more potential supply of shares, as the major shareholders can then sell theirs. This is the reason why most IPO shares perform well in the first few weeks of trading, only to fall back to their IPO prices within six months of their launch.
If we look at the market darlings of the past, we will notice that these counters usually have a number of funds as shareholders. The funds mop up the number of shares available and this in turn perpetuates the market darling status of these stocks. As stated, once supply is sucked up, even if demand remains the same, the stock price will continue to rise, even though the companies concerned may lack real fundamentals.
If one reflects on the dot-com boom, the same thing happened, where not only funds but also listed companies that wanted a part of the action were pushing up the share prices. Humans then need to try to rationalise to themselves why these counters deserve such a premium. During the dot-com days, such counters were valued at multiples of expenses. This is the folly of our human mind – trying to create a reason for everything. In actual fact, stock prices go up for the simple reason of demand and supply.This is why there is logic in following where the big money goes. If the big money leaves a stock, regardless of fundamentals or technicals, I too will be a seller.
This is also the reason why I do not have any concern about investing in a stock with limited float, if the company’s fundamentals are strong. After all, in any stock that I invest, I hope that the share price will go up. If stocks move because of demand and supply, then having a limited supply is really not a bad thing. Of course, if one wants to speculate and exit within days or weeks, then stocks with low liquidity will not appeal to him, as he will find it difficult to exit.
Imagine a room filled with hundreds of remisiers who now do more trading for themselves. Someone passes a rumour in the trading room or something is announced over the public address system. They are most likely to act almost simultaneously. Add in the brokers who trade larger amounts on behalf of the broking house. Factor in the close relationship that some remisiers have with other remisiers in other broking outfits. And add in the remisiers who subsequently call their clients to join in the party.
Then look at yourself as a punter. You are mostly all alone, as you are not sure whom you can trust. For me, I trust no one, as I do not want to be buying what others are selling to me. The market is about supply and demand, with all stocks having a limited supply. No trading system – TA (technical analysis) or otherwise – can fight a tsunami of orders. Do not kid yourself. This is the reality of our markets and it is why I always discourage folks from speculating in the market, unless it is just for the fun of it.
At the end of the day, the stock market is really a measure of demand and supply. When greed prevails, demand is high and stock prices are more likely to be pushed up by the fact that there are insufficient stocks available. On the other hand, when fear sets in, everyone will want to be rid of their stocks, increasing supply as a result. This then pushes down the share price, as there are now more stocks than takers.
To understand the stock market, one has to appreciate the effects of supply and demand on stock prices. In many ways, supply and demand is really an indirect measurement of fear and greed. Hot stocks are more exposed to the effects of fear and greed than fundamental stocks. Nevertheless, it is equally as important for fundamental investors to fully appreciate the power of supply and demand as this can help them with their investment decisions.
Chapter 2 - The Battlefield
We all have a tendency to try to find reasons why a stock goes up or down. Humans created technical analysis and fundamental analysis to try and plant reasons in share price movements. Newspapers and brokers write daily commentaries, which give the impression that they know more than us. The reality, though, is that the movement of stocks and shares is based on simple demand and supply. The unique thing about stocks and shares is that the number issued is finite. In other words, supply is limited. On the other hand, demand for these shares can be unlimited. This is in sharp contrast to futures where both supply and demand are theoretically unlimited. It is for this reason that I don’t trade in futures, as the strategy for futures is unlikely to be the same for stocks and shares.
What this means is that if supply is sucked up for whatever reason, even though the demand remains the same, the share price is likely to go up. The supply can be sucked up in a number of ways. If there is a strategic investor who keeps mopping up the supply from the open market, the number of shares available will be reduced. If however, the strategic investor is just taking a placement of new shares by the company, then this is unlikely to affect the number of shares floating around.
If the company buys back its own shares from the open market, the same phenomenon will also happen. The supply is being sucked up, resulting in less shares floating around.
This is why the game of stocks and shares is skewed towards players with deeper pockets. They can affect the supply more than a typical retail investor.
Theoretically, there is no art or science here. It is simply a matter of having the financial muscle to buy up enough shares to reduce the available float. Even the largest counter in the Singapore Exchange is small by US standards. Hence, every counter will be at the mercy of the laws of demand and supply.
With IPO stocks, the major shareholders are usually under moratorium for six months to a year, meaning that they will not be able to sell their shares during these post-IPO periods. As a result, the free float during these periods will be limited to the number of IPO shares offered for sale. In many cases, this may amount to just 20% of the total number of shares. As supply is limited during these six months to a year, the post-IPO stock price can rise sharply if demand is high. But when the moratorium is over, there will be a lot more potential supply of shares, as the major shareholders can then sell theirs. This is the reason why most IPO shares perform well in the first few weeks of trading, only to fall back to their IPO prices within six months of their launch.
If we look at the market darlings of the past, we will notice that these counters usually have a number of funds as shareholders. The funds mop up the number of shares available and this in turn perpetuates the market darling status of these stocks. As stated, once supply is sucked up, even if demand remains the same, the stock price will continue to rise, even though the companies concerned may lack real fundamentals.
If one reflects on the dot-com boom, the same thing happened, where not only funds but also listed companies that wanted a part of the action were pushing up the share prices. Humans then need to try to rationalise to themselves why these counters deserve such a premium. During the dot-com days, such counters were valued at multiples of expenses. This is the folly of our human mind – trying to create a reason for everything. In actual fact, stock prices go up for the simple reason of demand and supply.This is why there is logic in following where the big money goes. If the big money leaves a stock, regardless of fundamentals or technicals, I too will be a seller.
This is also the reason why I do not have any concern about investing in a stock with limited float, if the company’s fundamentals are strong. After all, in any stock that I invest, I hope that the share price will go up. If stocks move because of demand and supply, then having a limited supply is really not a bad thing. Of course, if one wants to speculate and exit within days or weeks, then stocks with low liquidity will not appeal to him, as he will find it difficult to exit.
Imagine a room filled with hundreds of remisiers who now do more trading for themselves. Someone passes a rumour in the trading room or something is announced over the public address system. They are most likely to act almost simultaneously. Add in the brokers who trade larger amounts on behalf of the broking house. Factor in the close relationship that some remisiers have with other remisiers in other broking outfits. And add in the remisiers who subsequently call their clients to join in the party.
Then look at yourself as a punter. You are mostly all alone, as you are not sure whom you can trust. For me, I trust no one, as I do not want to be buying what others are selling to me. The market is about supply and demand, with all stocks having a limited supply. No trading system – TA (technical analysis) or otherwise – can fight a tsunami of orders. Do not kid yourself. This is the reality of our markets and it is why I always discourage folks from speculating in the market, unless it is just for the fun of it.
At the end of the day, the stock market is really a measure of demand and supply. When greed prevails, demand is high and stock prices are more likely to be pushed up by the fact that there are insufficient stocks available. On the other hand, when fear sets in, everyone will want to be rid of their stocks, increasing supply as a result. This then pushes down the share price, as there are now more stocks than takers.
To understand the stock market, one has to appreciate the effects of supply and demand on stock prices. In many ways, supply and demand is really an indirect measurement of fear and greed. Hot stocks are more exposed to the effects of fear and greed than fundamental stocks. Nevertheless, it is equally as important for fundamental investors to fully appreciate the power of supply and demand as this can help them with their investment decisions.