Become a better investor
Lesson in Course: Market movements (beginner, 7min )
What does “the market” mean? Who decides what the price of something is?
We often hear the term "markets" used in economics and finance, but what are they? Markets are simply an exchange of one thing for another between two parties. The exchange can be for anything and between anyone—long ago, we were trading spices for fur. Today, the stock market is where investors trade ownerships of companies exchanged for money.
We might wonder, "how much of our spices do we trade for fur?" Even in the stock market, we might ask how is the price of a particular stock determined. The supply and demand for each ownership in each company are the dynamic forces that determine the market price of a stock.
Supply is the amount of a good or service available to buy.
When the supply of a given good or service increases, the resource becomes less scarce. The market responds by decreasing the price to sell the excess amount. We see this happening when grocery stores discount the extra candy days after Halloween. The opposite happens when there is a reduction in supply. Scarcity causes the market to drive up prices. For example, when oil-producing countries stop production, gasoline prices increase.
Demand is the amount of a good or service that people want to buy.
If we want something, we are willing to pay more. And if we don't want it as much, then we will pay less for it. When was the last time we only considered buying something if it was on sale? Therefore, the price of a good or investment will increase if there is greater demand for it. On the other hand, the price will decrease if the demand for it falls.
We can witness these dynamics at work in the stock market.
Investors who are willing to sell their shares of Apple stock make up the supply for Apple stock. New or existing investors who want to be more prominent owners in Apple become the demand for Apple stock. In one way or another, each seller has determined a price at which they would be willing to sell their Apple stock. Similarly, each buyer has determined the price at which they would be happy to buy Apple stock. The prices at which we decide to buy and sell are all determined, and therefore vary, individually.
Price is what we pay for something, and value is what we believe it's worth.
Value can be subjective, guided by individual tastes, preferences, and circumstances. While subtle, this distinction is what drives the market dynamics as a result of price changes. We experience this difference when we decide something is "overpriced" and decide not to purchase it. We believe its value is less than its price. However, if we choose to buy the same item on sale at a discounted price, we have decided that its value is now the same or higher than its price.
A transaction occurs when the price that someone is willing to sell their share of Apple stock matches the price of someone willing to buy a share of Apple stock. The headline stock price we see in quoted by the markets or our brokers is the price at which the last transaction occurred.
If more investors enter the market wanting to buy Apple stock, demand increases as the new investors outbid each other for the shares available, and the price per share will increase. On the other hand, if more investors enter the market wanting to sell Apple stock, supply increases, and the price per share fall as sellers undercut each other to offload shares.
There are many different methods to determine the value and the highest price that we would be willing to pay for an investment. Successful investors are wary of the impulsive side of human nature that plays a role in supply and demand dynamics.
Fads or emotional trading can often cause demand to rise and prices to skyrocket, followed by selloffs and collapses in demand. Previous examples in history include the dot-com bubble in the early 2000s. More recently, dogecoin, GME, and meme stocks make up other examples. As we learn more about companies and investing, we can better determine the value of an investment and our price.