Stock Market Wizard, U.S. Investing Champion Mark Minervini Shares Ideas and Wisdom Here FREE!
July 18, 2013
"What’s making the market go up?” “Why is my stock going down when the company has a great product and they just reported good earnings?” I’m asked questions like these all the time. Making money and controlling risk depends far more on discerning a stock’s probable price direction than knowing the “why” behind that movement. Indeed, often you will learn the “why” well after the opportunity to avoid loss or reap gain has passed. The only true answer for why your stock is moving up or down is that more dollars are bidding than offering and vice versa
Armed with an appreciation of the law of supply/demand, you can learn how to position your portfolio in stocks that have a good chance of attracting willing buyers who will bid your shares up—even though you may never know exactly why this is happening except perhaps in hindsight. Conversely, vigilant surveillance of price action can warn you to stay away from brewing disasters before share prices commence a severe discounting of the still-hidden problems at the business level
The study of price and volume is referred to as Technical Analysis. I believe it is just as “technical” to number-crunch “fundamentals” in a spreadsheet to make buy or sell decisions based on ratios or formulas as it is to simply watch whether a stock is under accumulation or distribution (in other words, being bought or sold in size)
Few people know how to recognize accumulation or distribution correctly, which often leads to the conclusion that it can’t be done or that it is ineffective. I have found the opposite to be true. A stock's price tells you exactly where supply and demand intersect to value the company at any given point in time. It is the law of supply and demand—the most fundamentally important element of any auction marketplace in action.
Buyers seek to pay the lowest price possible. However, there are others in the market competing for the same stock; as a result, they often have to pay up. The same is true for sellers. Seeking to dispose of their shares at the highest possible price, they must compete with others who are trying to do the same, and they often must settle for less. Actual trades are based on an auction market odel where a potential buyer bids a specific price for a stock and a potential seller asks or offers a specific price for the stock. When the bid and ask prices match, a sale takes place on a first-come, first-served basis.
THE SUPREME FUNDAMENTAL
In an auction market, the law of supply and demand ultimately establishes current value. At the end of the day, this fundamental force determines the direction of a stock’s price—plain and simple. If you have a willing buyer, whatever you’re selling is worth the price that the buyer will pay. This is an important concept to understand if you want real success in the stock market
In the conventional language of Wall Street, people label the study of price and volume as “technical analysis,” while they are pleased to award the term “fundamental analysis” to the study of earnings and other “serious” variables of corporate performance. The bias embedded in this nomenclature leads people astray – some to their ruin.
Supply and demand is the most fundamental element of any auction market. I’m not interested in theories of what a security “should” be worth; I care about its worth now. A stock is like a painting, it’s only worth what someone else is willing to pay. I’m looking for situations where there are willing buyers. Just as back in the days when farmers bartered cattle for corn or hogs for wheat, supply and demand always drives price. No matter how much technology we introduce to make markets faster and more efficient, these mechanisms get their marching orders from the price collision of supply and demand.
The market exhibits P/E characteristics as well. A prevalence of high P/E ratios is a function of bull markets; a prevalence of low P/Es is a function of bear markets. In times of confidence, investors are more willing to pay more premium than in times of uncertainty. As far as individual stocks are concerned, the pitfall of relying on a valuation measure such as the P/E ratio is that it can cause an investor to ignore the single-most valuable piece of information available: the supreme fundamental—supply and demand.
I recommend spending a significant amount of time and effort to learn how to correctly interpret the market forces of supply and demand. Learn to interpret supply and demand correctly, and you will make and preserve far more money than would be possible buying stocks that sell at supposed discounts to book value or have a low P/E.