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Simple and Concise: How the Stock Market Works

Posted on April 06, 2016

Simple and Concise: How the Stock Market Works

Posted on April 06, 2016

Where to begin:

Whatís the point of the stock market?
To make money.† If you buy Coke at $10.00 per share and it goes up to $20.00 you just profited. Prices are bid-up due to the demand that the crowd wants them. You buy at $10.00, sit back and watch everyone else buy it at higher and higher prices and all the while youíre sitting back profiting and then you sell to realize that profit before itís too late.† Conversely, you can short a stock.† Before a market falls, you can sell your shares at $20.00 and sit back and watch the price fall because the crowd too is selling it and before the stock reverses to the upside, you buy the shares at $10.00 thus realizing a profit.† Thatís it. Thatís the nature of the beast. J

The stock mkt is a barometer of the economy.
What does that mean? The economy is a measure of how well lots of companies are doingótheir profits or lack thereof resulting in defaulting on their debts.

How do you measure a single companyís performance?
Some say financial statements, since they believe that their stock price is the best current estimate of the companyís value and they believe that past price history does not affect its current price or projection thereof. They say this on the belief that price is not predictable AND itís serially independent of historical patterns.†

  • The problem with this belief is that they think that mkt participants are rational and well-informed and thus trading off well-informed information.

  • Not always well-informed and most human beings arenít rational in a crowdóthe mkts.

  • They believe that buy-and-hold is the best formula for trading and successful investingóitís not.†

Technical Analysists disagree with this belief.
They believe that prices have particular repeatable patterns that give greater likelihood (probability) to the coming reversal or continuation of the price trend currently in motion.† Price is predictable upon a given likelihood and patterns do exist. TA believes that being nimble is the best way to trade because itís about letting your profits run long and cutting your losses short, very short. They do not believe in buy-and-hold for a long period of time unless warranted by the trend and indicators they use.

How do you measure many companiesí prices as a measure of an economy?
Indexes of weighted representations of these many companies.† S&P 500, Dow Jones Industrial average, etc. You do this so as to get a GENERAL AVERAGE OR SENSE of HOW sectors of an economy are performing or the country as a whole is performing via their corporationís growth or lack thereof.

Any market is about finding the Trends.
Whatís the point to the stock market? Itís is about three things:
The key is to have your stop (selling price) already in mind or in-place before buying it. Know which market is trending. Up. Down. Sideways.
Know when to buy it.
Know when to sell.

Now, knowing this youíll want to mitigate volatility (the ups and downs prices).
Why? Because the sharp ups and downs create emotional stress on you because youíre losing big or winning big and most donít have any clue as to when they want to sell to realize their profit. Why? Because they never set a price target or goal for themselves. Thatís the key. Set the price target and thus, set a stop out price under your buy price so as to mitigate your loss and more importantly our emotional stress.

How do you mitigate the ups and downs of volatility?
Moving averages. They create a continuous average price plotted as a line over the actual prices so as to show you a moving average of the prices and thus visually guide your eye of which way the trend is going.
Before we go any further itís important to understand one thing: markets, for as long as civilization has been around from ancient Athena to the medieval Japanese Rice exchanges to the market exchanges in the 1800ís--- all have the same thing in common: CYCLES.

This shows the S&P 500 from 1900. These are long-term Secular cycles. Secular Bear markets are the sideways markets and the Bull Markets are the generational long-term 17-20 year advances.

They all cycle from trough to peak and back down to trough. Why? Human Emotion and psychology. At the trough, they start with unbelief because everyone still believes theyíre in a recession or depression.† Then prices begin to rise and people begin to believe in the uptrend and thus mkts move further higher. Then they get greedy and push the mkt further higher still. Then the mkt peaks and reverses.† It falls on unbelief because no oneís seen the sharp sell-off occur yet.† Then the sharp sell-off comes out of nowhere and belief in the sell-off takes hold thus pushing prices further down. Then they trough to their lowest on lots of fear. Thatís why itís said that the mkts are barometers of human emotion and psychology.

Bull markets take longer to build and bear markets fall hard and fast. Why? Scientifically itís been proven that fear is a stronger emotion than greedósurvival reasons.† Imminent threat, no matter the external source is still perceived the same because weíre human beings.

The business cycle is a cycle. It goes up and then goes down.† The going down, or bear market is called a correction because prices have to correct themselves back to the mean or average price after getting far too over-heated from greed and speculation. This is also called Mean Reversionóreverting back the Mean.

Thatís it. Thatís how the market works. Itís human emotion affecting the value of something that you either expect to go up or down in your favor.† Historical patterns exist so as to exploit the probability of going in your favor.† Identifying Trends help you exploit those probabilities. Knowing when to buy or sell is critical.

Jos. G. Sellery