|Understand the fundamentals of
markets. It will expose a lot of nonsense for you.
Equity markets are markets that trade in shares. Shares
are often called 'equities'. Ever wondered why?
A share usually gives the owner rights to 1) receive future dividends,
and 2) proceeds of a break-up or liquidation of the corporation,
and 3) hire/fire the directors. So a share is actually a set of
rights in tradeable form. In law, an equitable right is called an
'Rights to future dividends' is equivalent to 'rights
to future cash flows'. This is because a corporation may either
distribute all its cash as dividends or may retain some of it to
invest in the business, which will result in:
- larger dividends in the future, or
- a larger liquidation value
......both of which will end up in the pockets
of the shareholders.
Rights have value
In fact it is not necessary to understand or even agree with this.
The point is that a share carries rights to defined future financial
realisations of the corporation. Being financial rights they are
susceptible to financial or other analysis to establish a value.
And by the existence of stock markets these rights are tradeable.
Price is not the same as value..........
When a buyer and a seller meet they agree a price. But they do not
agree a value.
They may have no concept of value at all (because
they are pure market traders, and their judgement is not about value
but about what the next man will pay). More likely they do each
have an idea of value. But those values will be different, because:
- the buyer's value must be above the price
(or he would not buy);
- and the seller's value must be below the
price (or he would not sell).
The price of a share in a particular trade is a matter
of fact. But value is a much more elusive concept, shifting with
individuals, time and circumstance.
Two men standing in front of Nelson's Column to guess
its height may argue whether it closer to 100 feet or 300 feet.
But they would be pretty certain it it is within those limits (in
fact it is 185 feet). The observation constrains the guesswork.
And so it is with shares. The value constrains the price.
In that respect the market in shares is different
from markets in goods (or 'things'). A Rembrandt has no (financial)
value. But, if brought to market, it will have a price.
A purchase means a sale
And finally, the simplest but most profound feature of markets (all
- For every purchase there must be a willing
- For every sale there must be a willing buyer.
Try reciting the above the next time you are peddled
a formula for stock market success, bearing in mind that 80% of
the trades in the London market are done by professionals who know
more than you do.