If you are new to the stock market and are curious about the prices that move up and down, then you are not alone. You might think about how exactly are stock prices defined in Nepal? In this article, you will understand the following:
- Who defines the stock prices
- Different sell and Buy Orders that can be placed
- Benjamin Graham’s Idea of Mr. Market (Summary)
Who defines the stock prices
The most distinct image that probably comes to your mind when you think about the stock market is the color pattern that represents the price of a stock moving either up or down. But the thought of trying to answer how it is happening can be a bit overwhelming. How exactly are the prices of these stocks defined? The answer, to be honest, is quite simple. The price of stocks is defined by the buyers and the sellers who trade the shares.
The stock market moves up and down based on the number of buyers and sellers in the market at any given point in time. The market at a given point in time is either a buyer’s market or a seller’s market.
The buyer’s market
The buyer’s market is defined as a point in time when the number of sellers is greater than the number of buyers. In such a case, the buyers get to move the market as they are the minority. i.e., demand is less compared to the supply. And if you go back to classical economic theory. When the supply is greater than the demand, prices fall. As there are fewer buyers, they get to define the price and will most likely want to buy a stock at a bargain price.
The seller’s market
Conversely, The seller’s market is defined as a point in time when the number of sellers is less than the number of buyers. In such a case, the sellers get to move the market as they are the minority. i.e., demand is high compared to the supply. And if you go back to classical economics theory. When the supply is lower than the demand, prices go up. As sellers get to define the price, they will most likely want to sell a stock at a high price.
Hence, this constant tug of war between the buyers and the sellers is what moves the market. And this tug of war, in turn, defines the stock prices.
Different Sell and Buy Orders that can be placed
In Nepal, to buy or sell a stock in the secondary market, you need a broker. A broker acts as a mediator between the buyer and the seller. Every time a trade happens, the broker who completes the trade takes a small commission. When it comes to buying and selling a stock, there can be different kinds of orders that can be placed. In Nepal, we only use one of these methods. But I will highlight a few others to show a broad perspective on how trades can be accomplished.
Stop order is the most common form of order that can be placed by an individual with the broker to either buy or sell a stock. Let’s look at an example to illustrate this idea properly.
Ross has ten stocks of Nabil Bank, which he is willing to sell for Rs. 800 each. He then goes ahead and places a stop order, which tells the broker to sell the stock at exactly Rs 800. Now, joey wants to buy the ten stocks at Rs. 799. So he places a stop order, which tells the broker to buy the stock at exactly Rs 799. In this case, will the stock trade go through? Well, no. That is because both the buyers and the sellers disagree on the price. Now if chandler comes in and wants to sell his 10 Stocks of Nabil bank at Rs. 799. Then the stock trade will go through, and joey will get his ten stocks.
With that single transaction, the price of the stock of Nabil Bank falls to Rs. 799 until the next trade takes place. Hence you can imagine what happens when you scale this idea to include millions of people (The market constantly fluctuates).
In the market order, the stocks are sold at whatever price the buyer decides. And the reason why somebody would want to do this is to secure quick gains i.e. if the market just exploded in the last week then he/she who is holding the stock may want to make a quick profit by selling it. Hence they are willing to sell it at whatever the price that is available (The price is dictated by market demand). Or another reason is if someone quickly needs cash.
Limit order (Default in Nepal)
In a limit order, the buyer and the seller trade for the maximum benefit available. Trades like these are not a common thing here in Nepal. A limit sell order tells the broker to sell the stock to anyone willing to buy it for a fixed price or more. Conversely, a buy limit order tells the broker to buy the stock at a fixed price or less.
E.g., Ross has ten stocks of Nabil Bank, which he is willing to sell for Rs. 800 each or more. He then goes ahead and places a limit order, which tells the broker to sell the stock at Rs 800 or more. Now, joey wants to buy the ten stocks at Rs. 799 or less. So he places a limit order, which tells the broker to buy the stock at Rs 799 or less. In this case, will the stock trade go through? Well, no. That is because both the buyers and the sellers disagree on the price. Now, if chandler comes in and wants to sell his 10 Stocks of Nabil bank at Rs. 795, then the stock trade will go through.
Benjamin Graham’s Idea of Mr. Market (Summary)
As you can see from the things we discussed above that only a few trades can easily change the market price of a stock. That is why it should not matter what the market as a whole is doing in the short run. The trading of stocks at a certain price does not reflect the true value of a company. This is especially true in the short run. The market price of a stock, in the long run, is defined by how well the company does socially and financially.
Benjamin Graham’s Mr. Market is like an emotionally disturbed business partner. You can’t change his behavior, but you can react to it. Hence graham says to use Mr. Market as a servant and not as a guide. Mr. Market’s emotions are a projection of what the stock market is doing at a given point in time. When the market is doing good, Mr. Market keeps screaming at you to buy-in. Some of the things Mr. Market will say to you when the market is booming are :
- How can the market go down when things are going so well.
- You are an idiot to be not investing at this moment. You are losing money by not investing.
Similarly, when the market is crashing Mr. Market will say things like :
- you will never make money in the market, it’s hopeless
- Sell everything and save whatever you can.
Therefore, you should never follow Mr. market’s emotions. Here, Mr. Market is the representation of the general human perception of the stock market. You should always remain calm regardless of what Mr. Market tells you to do. Instead of following Mr. market sentiments, you should always try to competently evaluate your risk and invest in companies only if you think that the investment is worth it. Use the opportunities created by Mr. Market while not getting wrapped up in the emotions he creates. And if you do so, in the long run, this single principle will help you the most.
- Buyers and Sellers define the market price of a stock by competing with one other.
- There are many ways in which a stock can be sold or bought
- Mr. Market is like an emotionally disturbed business partner, and you should never follow what he says without evaluation.
Last articles on Value Investing