Nick Sciple: Almost everybody understands the
basic premise of investing: buy low and sell high.
Investors buy stocks and hope to sell
them for a profit after they move up in price.
But why do stock prices
move up and down in the first place?
If you’ve ever asked
that question, this video is for you.
In short, stock prices
change because of supply and demand.
Think of the stock market as one giant auction,
with investors making bids for one or another
stocks and offering to sell
their own all at the same time.
For example, Apple shares trade hands over
28 million times a day, which translates to
nearly 1,200 accepted bids
every second of every trading day.
Because there’s a limited supply of shares
available for sale, bidders must compete with
one another for access to shares.
The more intense the interest in a stock,
the more bidders there are attracted to it,
and the less interested current
shareholders are in selling their own stock.
As a result, potential buyers must bid higher
to buy the stock, and the stock price moves that.
This works the other way, as well.
When interest in a stock declines,
fewer competing bids are entered.
Holders are more interested in selling their stock,
and the lower the winning bid price must be.
But what determines investors’
interest in a stock? In short, it’s information.
Information comes in many forms,
from earnings reports, press releases, news stories,
court filings, tweets,
general hype, you name it.
Investors, whether consciously or not, incorporate
each new piece of information they come across
into their impression of a stock.
Of course, every investor reacts to new information
differently, and those reactions can range
widely, from apathy to panic to euphoria.
Depending on their reaction, investors may
choose to buy more shares, hold the shares
they have, or even sell.
In turn, these reactions are incorporated
into the share price, causing fluctuations
in the price and causing the
stock to move up and down.
Interestingly, the change in share price itself is
information that is incorporated by subsequent bidders,
and that cycle of information, reaction,
price move, and information back into the
system repeats once again.
When supply of a stock is limited and interest
is high, a stock’s price can skyrocket.
For a recent example of this phenomenon,
let’s take a quick look at Tilray, the first marijuana
company to go public directly
on the NASDAQ back in summer of 2018.
After going public at $17 a share, Tilray’s stock
soared, eventually reaching a peak of $300 a year.
Much of this rise was driven by a limited
supply of publicly available shares, as much
of the company’s stock was still privately
held by Peter Thiel’s Privateer Holdings,
as well as a limited availability of other publicly
invested cannabis producers for investors to purchase.
Combining the market’s rabid interest investing
in pot with an artificially limited supply
of shares led to Tilray’s rapid ascent.
However, as other marijuana companies began
publicly trading, demand for Tilray shares waned.
When the lockup for private equity investors
expired in January 2019, the number of shares
on the public market surged,
pushing down the stock.
Today, Tilray trades 78% below its highs.
The law of supply and demand remains undefeated.
If you can imagine this cycle of supply and
demand being repeated over and over again
among millions of investors and stocks
across the world each and every trading day,
you’ll have a working idea of the mechanisms
that influence daily fluctuations in stock price.
As you can probably guess, investors’ reactions
to new information aren’t always rational.
As long-term investors, we look for opportunities
to capitalize on the market’s short-term irrationality
to create long-term wealth.
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