Does anyone understand the stock market?
Oct 17, 2008 at 5:17 AM Thread Starter Post #1 of 21

helicopter34234

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I just started trading stocks (I know, great timing) and therefore I am trying to learn everything I can about how the market works.

First, aside form the IPO and the rare occurances when a company floats additional shares of stock (or the even rarer event a company will buy back some of their shares), all of the trading in the market is essentially in the secondary market (individual investor trading with another individual investor, not the company itself). So aside from these occurances it seems like there is a hard wall between the company and the secondary market where money does not flow into the company from the market and money does not flow out of the company into the secondary market. So lets say we are in the midst of a bubble and the price of a stock is skyrocketing, the company itself doesn't appear to benefit at all from these soaring stock prices (other than how it reflects on the image of the company or if they float more stocks). They get no additional money because their stock price tripled. Likewise lets say we are in the midst of a stock market panic (which we are) and the price of a stock goes almost to zero, why exactly should the company itself care other than the fact that it reflects on their image and it is unlikely they will be able to float any more shares until the price recovers. I mean, they got their money from the IPO at a decent rate, they have this money, what do they care that johny stock market investor is holding this stock and can't find a decent buyer, not their problem. Where is the flaw in my logic? Lets say our company is doing really crappy and their earnings are really bad, this doesn't really affect the stock holder other than the fact that he will have a hard time trying to sell it for a good price. It almost appears like a conundrum that the value of a stock is only set by what someone else in the secondary market will want to pay for it. Lets say I own stock in a really great company but for some reason noone wants to buy it from me, is my equity ownership valueless? How could it be, I own a portion of a company that is doing really well. Some of you probably would retort that its not valueless because eventually investors will realize the company is good and want to pay you good money for your stock. For those of you thinking this, you are missing my point I am trying to illustrate. Something doesn't just have value because people will pay you money for it, it has to have some intrinsic value to. A car has value cause you can drive it, not just because someone would buy it from you. Land has value because someone can build something on it, not just some day someone would buy it from you. Lets imagine a situation, we have a company which is likely not going to go out of business or be bought out for at least 200 years (therefore your stock will not be bought out nor will you receive cash for the liquid of assets on bankruptcy, also no dividends) and you own stock in this company. Lets say all of a sudden no one wants to buy your stock and for some unknown reason noone will ever want to buy it from you again on the secondary market, is your stock all of sudden worthless. How could it be, you own a portion of the company.

I know what I am have said may sound ridiculous or simplistic but I believe there is some subtly here. It goes into the nature of how you value a stock. The stock market is dominated by psychology, investors panic or becoming overly heated and cause bubbles. Good investors are supposed to asses intrinsic value in stocks and only purchase them when they are priced around their intrinsic value. But how can a stock have intrinsic value if they are only valued on sale to another investor who he then can only get value on another sale, and so on.

Ok, my second question... I notice that when I graph some of my stocks with the NASDAQ or the Dow that my stocks will very closely track these indices. The tracking is very distinctive over the short term, maybe a couple of days but if you graph both on a longer time scale the correlation just isn't really there as strong at all. Essentially you are noticing that the "noise" in these stock prices are well correlated. Now this may be obvious for a stock that is a heavily weighted part of the index, but even stocks that are completely unrelated to the index will have this correlation. The less related to the index the stock is the less it correlates over longer time scales, but it is almost uncanny how closely the noise correlates. Now I don't know if this is just specific to the current state of events (high volatillity with investors hanging on every piece of news) but I think its very interesting. Like you may see it rise for a few hours, then all of a sudden drop at a particular hour. Are most investors really that informed that hour by hour they are finding out information about the company and deciding all collectively sell (or buy). I am no where near this well informed, I check my stock periodically through the day but I don't read press releases or articles on whats going on constantly throughout my day to be a member of this coordinated buying and selling.
 
Oct 17, 2008 at 5:51 AM Post #2 of 21

vagarach

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With the kind of questions you are asking, you should just go straight to the literature, read some books. You're hitting on technical analysis, fundamental analysis, time series analysis, signaling theory, and other things, all at once.

Check this book out Investments by Bodie, Kane and Marcus.

A solid text with not too much heaviness on the math, and a broad, sweeping coverage of all the main theories, their flaws, accuracies, and so on. As a bonus, this text reads very well, which not all finance books can claim! It will really give you a view on how things work (or how we think things work). Rather big, my paperback one is about 1000 pages, but it does cover a lot. I'm not sure if it's really ok for total beginners, I've done quite a bit of portfolio theory and derivatives pricing as part of my degree, but you seem very keen.

Good luck.

(okay, I did some looking, and it is good as an introduction!)
 
Oct 17, 2008 at 9:38 AM Post #3 of 21

Cankin

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^ x2

For those who would like to work in financial industries(not sure how many would consider that under the current crisis), you should be getting a CFA Charter or equivalent

I'll probably be writing my first exam within 1 year or my graduation
 
Oct 17, 2008 at 9:41 AM Post #4 of 21

Lazarus Short

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Whatever theory/analysis you study, keep in mind that you're dealing with mass psychology. Emotion is a BIG factor, and it can be as illogical as logical. Speaking of illogical, why are you, an admitted neophyte, trading already? I'm sure that your stockbroker "saw you coming."

Laz
 
Oct 17, 2008 at 10:35 AM Post #5 of 21

nsx_23

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Ah, another fellow beginner trader.

I'm actually looking to buy into shares as well, more as a learning experience rather than a serious source of income. The trouble is, I don't know much about share either, and am still pondering over which ones to buy....
 
Oct 17, 2008 at 1:26 PM Post #6 of 21

Orcin

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Go to Las Vegas and play craps or blackjack. It is much easier to master, with virtually the same outcome.
 
Oct 17, 2008 at 7:53 PM Post #7 of 21

helicopter34234

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Quote:

Speaking of illogical, why are you, an admitted neophyte, trading already? I'm sure that your stockbroker "saw you coming."


My girlfriends dad is a stock market guru and he gave me advice on a good safe company (Oracle) about 2 months ago before everything started to so I decided to buy in about a month ago when prices were relatively low. I have money saved that I could afford to lose some of it (not that I want to). Learning about the stock market is something that I had wanted to do for a while and now is the time (no kids, no loans, no real responsiblity) and I don't really need the money for a few years (I am in graduate school and I live very cheaply). I consider the investment as one also in my education (you are so much more modivated to learn about the stock market, read business news, and read books on finance and investment when you have money in the market than when you don't). I don't think that in a normal market you really have to be up to the minute informed when you are making conservative investments (good solid companies and diversified investments) as opposed to speculation. I am by no means speculating heavily on any of my investments.

Quote:

I'm sure that your stockbroker "saw you coming."


I trade through Scott Trade, I don't have personal contact with a broker nor do I take their advice.

Quote:

I'm actually looking to buy into shares as well, more as a learning experience rather than a serious source of income.


Exactly, everyone has to start somewhere. If you start conservatively and you don't need your money back very soon (and you can afford to lose a little money) I don't think its bad to dive in head first to the market. All you "experts" who are investing have no idea whats going on right now either. Its anyone's ball game.

Quote:

Go to Las Vegas and play craps or blackjack. It is much easier to master, with virtually the same outcome.


True if you are speculating and buying up risky growth stocks then you are gambling quite a bit (still better odds in most cases than vegas). But it is not true for a conservative diversified investment plan, the market average has relatively consistant growth throughout the years (in the long term) and conservative investors will under most market conditions make more money in conservative equity stocks than they would in stuff like bonds or worse keeping it in the bank. Inflation is about 4% so if you are making less than that in your bank account you are losing investment.

Part of me can't wait until I can buy my first house so that I can have a mortage. Now let me explain, lets say I have a mortage at 7% annual interest, then any extra payments I make on that mortage are essentially investments that are returning 7% annual interest. Its a safe gaurenteed return. Now I know there is a problem with this, there is no liquidity in this investment (you can't ask for your money back from a mortage company when you want to buy a TV) so you have to make sure you have enough cash in a rainy day fund. Also some of you might say, your house should not be considered an investment, your house gets old needs to be fixed, needs furniture to fill it up. So I say, yes I agree but everyone needs a house (or a place to rent) so its not something you can do without. I am not saying buy a huge house as an investment, I am saying buy something modest so that you have a place to live. And almost everyone who buys a house needs a mortage. So if you are going to have a house and mortage anyway then paying off your mortage faster is a good investment. If you are paying 7% on your mortage and your are making 4% in the bank or maybe 6% in the stock market, put this money into making extra payments on yoru mortage (while keeping enough cash for safety).
 
Oct 17, 2008 at 8:50 PM Post #8 of 21

helicopter34234

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So I have a lot more reading to do but I am really curious about this second question. What causes this noise in the stock price over the day? People must be responding to some definitive information as the noise in any one stock seems to correlate to the noise in the Dow or the NASDAQ indices (even when that stock isn't necassarily related to that index). What hour by hour news is being released that is having such a big sway on people's opinions of the stock market as a whole. Is this just a relatively recent phenomenon of hair trigger volatility (in light of our recent crash)?
 
Oct 17, 2008 at 9:24 PM Post #9 of 21

Wmcmanus

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No. Nobody understands it. Of course, there are always those who think they do, but many of them have recently been handed their shirts. For what it's worth, I'm a CFA and CPA, but don't think for a moment that I really understand the markets.
 
Oct 17, 2008 at 11:27 PM Post #10 of 21

helicopter34234

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Vagarach, I will definitely check out "Investments by Bodie, Kane and Marcus" but the book is 1000 pages so I don't know how quickly I will make it through that. On the other hand, does anyone else have any suggestions for reading material that are a little more directed toward someone who really only wants to develop a sucessful yet conservative personal investment plan including stocks, bonds, and other assets. I am getting my PhD in mechanical and aerospace engineering and I may at some time in the future be somewhat in charge of a company's finances but I will probably take the appropriate business classes when that time comes. For now I am more focused on trying to understand what is necassary to be a smart personal investor.
 
Oct 17, 2008 at 11:43 PM Post #11 of 21

digger945

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I've read and heard many say that until after the elections you will see a lot of volatility in the stock market, and it can be directly related to Obama's ratings in the poll's, as his stated policy is that of very tight financial regulation(for wall street people). As Obama's ratings go up, the stock market goes wild, as his ratings go down, the market settles.

This is not in any way my personal opinion, it is simply the exact words of the local radio and news papers.

Evidently the election of the next president is something that wall street watches pretty closely.

Again, I want to say that this is not my personal opinion. Just repeating what I hear every day.
 
Oct 18, 2008 at 12:55 AM Post #12 of 21

vagarach

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Quote:

Originally Posted by helicopter34234 /img/forum/go_quote.gif
Vagarach, I will definitely check out "Investments by Bodie, Kane and Marcus"...


Yeah, it is rather big, but it is a vast, vast area. For conservative plans, I've heard that at least on a personal level, keep whatever your age is as a percent in bonds/tbills, and the rest in a mixed actively/passively managed, diversified(!) portfolio. This rule of thumb captures some of the change in your level of risk aversion and so on but pays no heed to liquidity---up until retirement it could work quite well.

There are just so many books out there, all purporting to be for the common man who just wants to save some money BUT wants his 12% return too AND have it in a safe place, it just makes me balk. Portfolio management firms too, until the amount of capital you have with them is more than a $1mil or so they just hand off your money to some guy who is doing passive management (delivered from up high at that) and active management maybe once a month. It's just too much work otherwise! The one thing that the lone investor can't get into is the benefit of some of the high end funds or funds of funds (i.e. very large minimum pfs), but you can tap some of that market with other instruments, like PPNs and similar, whereas these large firms can use them in your pf.

I am a firm believer in understanding the theory, how financial instruments work, and researching and investing in firms you believe in. Warren Buffet said 'pah, nonsense' to all those dotcom stocks, and didn't lose any money when the thing collapsed. You have to have that kind of wisdom as a personal investor, and that is a very individual thing. They say the best fund managers never make as much as the big winners when the market is up, but they lose far less when the market it down.

As for intraday fluctuations, or noise, the cause can be blithely identified as a result of the market clearing, supply and demand, how big the spread is, and of course, emotions. Obviously, it is much deeper than that! Things like the efficient market hypothesis (in its strongest form) assert that the stock price includes all available information, public and confidential, but people who follow behavioral finance look at it differently with psychology and other fields of research.

The correlation is just that, indeed, the best index would capture the whole market with just one number, and achieve perfect correlation with every stock price! Taking things further you can look at the auto-correlation function of the stock price over time, which could reveal some more information. There is a whole lot of stuff on modeling stock prices, intra-day variances, applying a lot of probability theory, stochastic calculus and similar, but these are models without application to the common man. Being a eng phd you should have no problem with the math, so look up ARCH/GARCH models and their upgraded versions, in trying to model stock prices and intraday variations you have to first find out why they happen, so you could discover something there.

phew, that was waaaay too many words (sorry if I put all of head-fi to sleep), and I should be studying for my exam on brownian motion and interest rate models
redface.gif
This is sorta related, so it counts, right?
wink.gif
 
Oct 18, 2008 at 6:24 AM Post #13 of 21

helicopter34234

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Great article from a very well respected ivestor, Warren Buffett.
http://www.nytimes.com/2008/10/17/o...gin&oref=slogin

This really makes sense, you can't predict the market no matter how seasoned you are. You can maybe make educated guesses if you are really good and beat out your losses with your gains on occasion but investing in the market should be for longer term. I like the idea of cost averaging investments where you put the same amount of money into your equity accounts each month (essentially automatically buying more shares when the market is down). If you ever see the price of your stock rise too much, maybe it is time to sell.
 
Oct 18, 2008 at 7:13 AM Post #14 of 21

XXII

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Quote:

Originally Posted by helicopter34234 /img/forum/go_quote.gif
I am getting my PhD in mechanical and aerospace engineering and I may at some time in the future be somewhat in charge of a company's finances but I will probably take the appropriate business classes when that time comes.


Wow, if you come from such a technical background you should consider reading up on some mathematical modelling of Stock prices (i.e. Black Scholes...). A very beautiful theory.
 
Oct 18, 2008 at 8:00 AM Post #15 of 21

helicopter34234

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Quote:

Wow, if you come from such a technical background you should consider reading up on some mathematical modelling of Stock prices (i.e. Black Scholes...).


My friends and I are planning on taking a course related to finance or investing, we aren't 100% sure which course will be most beneficial to someone trying to understand and develop a personal investment strategy. I was thinking econometrics might be useful in stock valuation, but I am not sure.

Quote:

A very beautiful theory


Yes, I was doing a little reading up on what the finance and econ graduate students work on, I was impressed with the complexity of some of the models and analysis they use.

For now I will try to break into the subject by reading (listening to audiobooks) on general market principals and investment strategies. I decided to start with the more conservative viewpoints of books like "A Random Walk Down Wall Street" and "Irrational Exuberance". Then I might work my way up to books making more dubious claims teaching you how to predict the market and get you rich quick.
 

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