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Everytime the market moves, people scramble to come up with reasons to explain why it did so. If the market went up after a certain event, like say, an economic report, then the move is attributed to that news. If the market went down and there was no news, then it may have been “a lack of buyers” or maybe the old standby, “profit taking”.
I sympathize with journalists who have to constantly write about the market and to concisely communicate to an uneducated general public what is happening. They can be forgiven for grasping at straws and giving explanations which really have no empirical legs to stand on. What else can they do? They’ve miles of white space and gallons of ink with which to fill them.
But my all time favourite is the explanation that many bandy about: “More buyers than sellers”. That is, if the market went up, it is explained by some as an unbalance between the buyers and the sellers. And if the market goes down, these same people say there were more sellers than buyers.
I’m sure you’ve heard this expression. But think about it for a second. Is it true? Can buyers ever outnumber sellers?
It may help to understand this by thinking about what a transaction is. I think of a transaction as concomitant agreement on price and disagreement on value.
In other words, I may agree with another person that my shares of Google (GOOG) should be priced at $550 but I disagree on the value of the shares. I value them less than he or she. That’s why we are able to engage in a transaction. I sell GOOG. The other person buys GOOG. But while we disagree on the worth of the shares, we do agree on the price - or there would be no transaction.
In this framework, can there ever be more buyers than sellers? No! Every single transaction needs to have both a buyer and a seller. Clearly then the explanation of an imbalance of buyers and sellers is simply incorrect. There can never be more buyers or more sellers. There must always be the same amount of shares on each side. Or all we have are bids and asks - no transactions.
So why then do prices move at all if there must always be complete congruence between buyers and sellers? Why does price fluctuate at all?
Well, it isn’t the amount of buyers or sellers but their psychological makeup. Prices move up because buyers are more aggressive in their desire to buy than sellers are in their desire to sell. And vice versa.
That’s why I cringe a little whenever I hear a trader or investor explain market moves by saying that there were more buyers or sellers. Am I being nitpicky? Maybe. This stuff will probably not make or break you as a successful trader. Although I would assume that if you are interested in the markets you would take the time to think about the underlying framework and how it all really works.
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