Many experienced investors do not understand the trading and pricing system of a stock market. In this ignorance, they do not understand how a stock market can suddenly go down or up by a large percentage.
In our everyday lives, we are used to “fixed prices”, like at the department store or supermarket. This is a “take it or leave it” pricing system. The seller fixes the price and the buyer has the option to buy or not.
When we buy a T-shirt at the Baclaran market or an automobile from an individual or a dealership, this is a “Contract Market”. The price is negotiated between the buyer and seller. Usually, the seller starts the negotiation and the buyer offers a lower price until the two parties meet at an agreeable price, like what you see on the television series Pawn Stars.
In the financial markets, the commodity exchanges used to operate exclusively on a contract pricing system between two parties. That has changed to a structure similar to the stock exchanges because of electronic trading, which does not easily lend itself to contract negotiation.
Stock markets determine prices based on an “Auction System”, like on the US television series Storage Wars. The “seller” asks if anyone in the group of buyers is willing to pay $200 for a storage unit. If there are no takers, he lowers the price until someone is willing to bid. That is how the stock market works and why buyers, not sellers, determine stock prices.
You want to sell your shares of Ayala Corp. and “offer” or “ask” P900. If no one is willing to pay that price, you may drop the offer. Another seller may come in at a lower price than you to have their shares be bought first.
Notice that as long as buyers are not willing to take the price, sellers will—theoretically—lower the price until they find a buyer. If the sellers are not willing to go any lower and the buyers will not pay any higher, there is no transaction or liquidity. Liquidity is ultimately determined by the buyer.
We are told that stock prices went down because “there were more sellers than buyers”. There is always the same “number” of buyers and sellers. It should read, “There were less buyers at a higher price”. If the local stock market trades P10 billion and goes up 100 points, there was P10 billion of selling and P10 billion of buying. The difference was that buyers were willing to pay higher prices. The same is true for the down side.
This past Thursday, the Philippine Composite Index was down 65 points on a trading volume of P5.6 billion. Again, the same peso amount of buying and selling. But on that day, buyers of Globe Telecom were not wiling to pay the previous day’s price of P2,150. Buyers—58 percent —were only willing to buy at P2,078 and another 26 percent were willing to buy at P2,080.
It is not as if the sellers walked in that day and said, “I want to sell my Globe shares at a price 3.35 percent lower than yesterday”. The sellers did not have a choice because P2,080 was the highest price that most of the available buyers were willing to pay. Buyers determine the price; not the sellers.
Panic selling and panic buying happens in the wake of strong one-way price movements. This is the “irrational exuberance”—and “irrational depression”—that can overtake the market on a short term basis. Prices are determined by the buyer, which proves that “whoever has the gold makes the rules”.
E-mail me at mangun@gmail.com. Visit my web site at www.mangunonmarkets.com. Follow me on Twitter @mangunonmarkets. PSE stock-market information and technical analysis tools provided by the COL Financial Group Inc.