In a market, you trade dollars for other valuable things.
In a stock market, you trade dollars for stocks.
Why is a stock valuable?
It represents a small piece of a company. If you bought up all the pieces of a company, you would own the entire company. But most people can't buy an entire company, so they buy small pieces of a company instead.
Why would you want to trade dollars for a small piece of a company?
A few reasons:
1. Because a company owns valuable assets, and if you own part of a company, then you own a part of those valuable assets.
2. Because a company earns money, and if you own part of a company, then you get some of that money. (Either directly as a dividend, or indirectly as more your shares gain in value.) Think about it: if you own part of a company, then for some small fraction of the day, every single person in that company is working for YOU. YOU get the fruits of their labors for that fraction of the day. If you do this with enough companies, then you can quit your job.
3. Because a company makes decisions, and if you own part of the company, then you get to vote on how those decisions are made.
4. Because dollars become less valuable over time, by about 2% per year, assuming that the economy is operating as planned. (Inflation.)
Direct benefit: liquidity - whether you need to buy or to sell, you have a place where you'll find a counterpart quickly.
Indirect benefit: information - just watching the bets lets you have an idea about how much people with skin in the game value things, letting you take better decisions about resources allocation.
The knowledge that I can get out of my investment any time I want at the current market price makes me much more willing to invest in the first place. If I know that it can take several month to get out of an investment or that I have to sell at a discount to get a fast deal then I'm more likely to sit on more of my money in case I need it quickly.
However, the reality is if the market disappeared today informal markets would quickly take it's place consider what happens to pre IPO stock.
I can't imagine selling a position would have any influence on price until it's a significant percentage of the market cap. The median cap of the Russell 2000 (an american small cap index) is 809 M [0].
Do most people really have multi-million positions in a single small cap company?
Anyway, my point is simply that trades are the mechanism that changes price. So, you can't expect to sell arbitrary amounts of stock at the current clearing price.
+/- a few cents might not seem like much but drops can spiral with relatively small initial sales.
The reality is the current ticker price is only meaningful up to mid sized transactions.
Additionally, IPOs are almost priced incorrrectly, and show the problems with the informal market.
Illiquid investments need to generate higher returns to make up for the fact they're illiquid, in comparison to liquid ones.
How would any of the other trading help my business, or anyone else?
The presence of the secondary market makes the initial offering (sales) of shares easier.
Imagine company A is making a primary offering (direct sales of shares from the company to an investor), but that those shares do not have a ready secondary market.
Imagine company B is making the same primary offering, but there is a deeply liquid secondary market.
Company A and Company B are otherwise identical (line of business, revenue, profit, outlook for the future, etc). Investors will much more readily invest in company B.
Ceteris paribus, volatility is negatively correlated to trading volumes: if your shares are only exchanged twice a week (actual trading volumes for a small company on some exotic exchange) the price variations will inevitably happen in large steps, which does not reassure investors. And if the company is not publicly traded, who knows what the price of the next transaction will be ?
A lively market for an investment vehicle opens the possibility of derivatives, which are valuable to investors interested in the company but whose appetite for risk is limited. So if your company's shares trade has derivatives, it makes them more attractive.
(Similar to how money or even bitcoin is only useful if you can pass it on.)
Indirect: that seems like a losing game. Why would gambling on a companies future ever help anyone(except the lucky?).
Most transactions in the market are not gambling. Trades happen, yes, but that is because the prospects of companies are continually changing. When it became apparent pretty much everyone would move to Netflix and streaming video, would you want to continue holding Blockbuster stock? No; you would want to sell it.
People who simply "gamble" in the market lose money about as often as they gain it, and soon stop. Hedge funds and mutual funds generally try to invest in shares on a longer-term basis rather than continually trading them; trading incurs transaction costs, and if an investment was correct and is generating better-than-benchmark returns there is no reason to sell it.
The "day trading" books you might see at your local Barnes and Noble are get-rich-quick books and are not representative of the actual professional investment industry.
For every seller, there's a buyer. The market will settle on a price at which those are evenly matched---even if that's close to zero.
You have to offer a good enough price on your Blockbuster stock to find a buyer who thinks it's a good idea. (Unless it's someone who has to cover a short position, those guys are basically forced to buy. But they'll still buy from the seller with the best price.)
Prediction markets are the most efficient way to make societal decisions; they allow everyone to combine their information and predictions without having to directly coordinate with each other. There's academic literature arguing they'd be the best way to do politics etc. At the moment all we do with them is capital allocation, but that has real-world effects: ultimately the idea is to give more money to companies that can use it better (so that they then e.g. build more factories, hire more people, make relevant buyouts) and less money to companies that will make less good use of it.
Similarly, a company that does well socially (e.g, a public hospital) but not economically would get obliterated in the stock market.
That would be regulatory failure - it is not the market's fault if the government is weak... Fix the government, get decent labor laws, let companies internalize externalities, regulate environmental impact !
> Similarly, a company that does well socially (e.g, a public hospital) but not economically would get obliterated in the stock market
Which is why, in civilized countries, public services are provided by the government or on behalf of the government.
Foisting government responsibilities upon the market is bound to create disappointment...
In any moment it seems like you're just buying thin air for money and selling that air later for (hopefully) more money. But that's the short-term view of it. In the long run you are taking a stake in a company that you hope as a whole will be worth more in the future than it is today. That stake gives you legal right of ownership to a percentage of that company and its cashflows. If it's a dividend paying company you collect regular profits from it as well.
There are lots of small intermediaries in finance, like in any industry. They make money because they provide services that others find valuable.
Thanks for trying though. Edit: I'm editing further to ask more
Edit2: so you said that they make money because they provide services. What services could you offer when (from what I can see): Company A: wants investors. So promises them a portion of profit based on investment.
I can't see any value from any other provider there.
Now I may be wrong, and I'll admit straight off the bat I have * no idea * how it all works, but it seems to meet that there isn't any other value provided to the company, or to the initial investor aside from, buy these shares of the company, hold these shares, or I want to sell these shares.
At a simple level: investors might want to invest in a given company at any point on the risk/return curve, rather than just the one their stock or a particular bond issue is set at. They might want to invest in a particular sector rather than having a view on specific companies. They might want to invest in a company whose stocks are priced in a different currency from their own, but without exposing themselves to the currency movements. They might believe a particular sector will outperform the market without wanting to take a view on how the overall market will perform. They might have a big chunk of a commodity to sell in six months and want to spread out the sale according to whenever gets the best price. And all of these views do, ultimately, filter down and translate into concrete capital allocation in the real world: maybe a particular sector ends up hiring more people or building more factories because they have more capital, and the economy does better for everyone when capital is spent in the best way. (Of course it's possible for everyone to be wrong, but the basic idea that averaging out everyone's buying and selling results in our best guess for where the money should go seems sound).
Of course mechanically you end up with a lot of intervening speculators - in between investor A who has a particular set of views about the market and company B that desires capital on particular terms, there might be dozens of intermediaries. But I see that as no different from the way that most real-world transactions are business-to-business - in between you buying a furniture cabinet and the people growing the wood or mining the metal there are dozens of intermediate suppliers, each with their own particular speciality, all adding a little bit of value.
I still don't see a reason why these people between you and the business have any useful reason to exist. Unless for gambling, Wich as far as I can tell is what it is. (And I'm not talking about initial investment, I'm talking about people gambling o weather the value will go up or down).
Ontop of all that, what benefit does it provide to the initial company if people are gambling if the value goes up or down by a few percent? That just seems like a different form of book making.
Edit:
You know upon second read, it seems there is so much hand waving to mitigate investor risk, that completely ignores the idea that you are purchasing a piece of a company, that really seems that the entire system is beibg rebuilt to keep certain people making money.
If I want an investor to purchase 20% of my company. For 20% profit, why should any sort of bonds, currency devaluation come into fact.
As far as I see it: you are directly purchasing a portion of my company. That is a share right? If the value goes up, assumably your dividend will increase. Otherwise it will decrease. What the value of my countries dollar happens, has no effect on the percentile of my company.
All I can see is a lot of hand waving to make things different.
Side note: I'd really like to see a logical reason for any of this.
Edit to lostboys: I think the thread is too long and I can't directly respond, my apologies.
Once the business sells a portion to investors, those portions can be resold. This I get, where all the shorting and everything else comes from, makes me wonder about the entire stock system. At what point is it not about the investment about the business, and gambling about how it will go in the future(eg shorting). That and the whole system akin to it, is the part that is making me wonder how it was ever allowed.
You'd have to find an investor who wanted to purchase 20% of your company, which is quite a big ask in a lot of respects: they'd be very heavily exposed to one single company, their risk requirements would have to align exactly with yours, they would have to be using the same currency as you. Bottom line is, you'd get a pretty poor price - which is why the institutions that end up buying 20% of companies are the big banks who can slice that exposure and find buyers for the different pieces. (Just like if you're trying to source a given component for manufacturing, you may well end up going through a broker and an importer rather than dealing directly with whoever makes that component). If the banks weren't able to give a better price, no-one would sell through them.
> What the value of my countries dollar happens, has no effect on the percentile of my company.
Sure, but if I'm a Japanese pension fund and the value of my investment drops by 5% because the dollar has weakened against the yen, my investors are going to ask me some awkward questions.
> At what point is it not about the investment about the business, and gambling about how it will go in the future(eg shorting).
It is investment: no-one's doing this for fun (well, maybe a few people are, but they're only hurting themselves if so), they're doing it to make money, which means figuring out what's actually valuable. At the end of the day the only money going into the system is business profits, so the only way to make money is to do something that makes more money for the economy (or, sure, you can do zero-sum bets - but that's not a profitable business to be in in the long term).
> That and the whole system akin to it, is the part that is making me wonder how it was ever allowed.
There's no "allow"; it's a free country, you can buy and sell stuff you own. But the reason the markets are active is because they're productive.
Actually, most people could not directly purchase their shares if we didn't have a stock market. Companies in general would be owned only by relatively wealthy people or by other companies. Stock markets allow more ordinary people to share in the profits of companies. They democratize the ownership of the means of production in society.
> (which they offered to gain temporary income to make purchases before their cash flow allowed)
The income raised by stock offerings is not temporary; it is not a loan to be paid back. That capital becomes part of the company. The company might use that to purchase assets that stay part of the company or to buy inventory which it will then sell resulting in getting that money back plus profit.
> Once the business sells a portion to investors, those portions can be resold.
Without a stock market, they could not be resold without great difficulty. Investor A, who wanted to sell his share, perhaps after new management had taken over and was now driving the company into the ground, would have to find other another investor, Investor B, to buy it, and if Investor B didn't want to purchase the exact amount Investor A was selling at a mutually agreeable price, Investor A would have to begin a new search to sell the remainder of his share. This is one way liquity is such a big help.
> making me wonder how it was ever allowed.
The buying and selling of things has never needed to be explicitly allowed; in most modern nations, individuals are free to buy and sell things they own.
What, in your mind, is the difference? I think it's a reasonable viewpoint to say that all investment in a business is a speculative bet (ie. gambling) on its future. In that sense, shorting is no different than going long (you just believe it's going the opposite direction and want to express that viewpoint to the rest of the market).
Third parties offer services like spreads CDO's and binary bets (which actually are gambling).
Stock markets act as a market i.e. introducing investors to companies that need capital for example my latest buy was an American Investment trust Tetragon with out a stock market how would I be able to invest in them ?
If I buy APPL today at X, I hope in 3 days it will be Y so I can sell. That's a gamble.
You can use all forms of analysis and assessment to give you more confidence in the gamble, but it's absolutely a gamble.
If you can identify an temporary overhang on a particular share you can make money as the discount narrows as I have done with Witan I also made a lot on Electra private equity as it was targeted by an activist investor and they realised some of their PE investments
- company A who's shares will be traded in a deep and liquid market, so you can get rid of them whenever you need money (eg for unforeseen circumstances)
- company B who's shares can not be sold easily afterwards?
If the answer is A, you see how the secondary market can help the first issuer reap a higher price, thus helping the company succeed.
By the way, you are not alone. I was asking myself very similar questions a while ago. Mostly in the form of: "why would a company's management ever care about share price?" (Outside of when it's trying to raise more capital.)
At the same time, share price isn't something management can directly change. They do so by running the business well so that it generates profits and growth.
So the question "why would a company's management ever care about share price?" can be answered "because it's usually an indicator of whether or not they're doing a good job and provides job security."
For me the topic's related to the grandparent comment's question about 'why should the company (or its management) care about the stock market'?
Also keep in mind that most trades are executed with a hedge in place to prevent losses. The market is rarely a case of bet a million on black trades. That said my knowledge is comes from knowing how energy and metals are traded.
Investors have capital, and want to see somebody produce something extra with that capital. The main variables are the size of the capital, and the risk profile the investor is prepared to accept.
Businesses require funding to grow[1]. The main variables are the nature of the reparations, and the control they are willing to concede.
The scale of the four dimensions above means that there is no one size fits method to transfer capital from investors to businesses and vice versa. For instance, Capital: $2 to $2bn; Risk: I'm prepared to lose it all, to I want guaranteed, fixed returns; Reparations: I'll pay 20% interest, to you can have non-negotiable dividend; Control: you can own debt, or you can have a seat on my board.
The evolutionary nature of the finance industry has gone from age old future contracts ("I'll give you $100 next October for your crop of wheat") to other more exotic derivatives e.g. Snowball Swap. Even if you as an individual do not need complex options like that, you may invest in a 401k that does.
[1]not limited to pure funding. Consider a manufacturer that makes a product that takes a year to make. If they sell to a foreign market, they cannot risk working and consuming raw materials for a year in one currency to be paid in another currency at the end of the order that varies. Thus, an FX Future gives the manufacturer the confidence to agree a deal and concentrate on the business fundamentals, not global currency markets.
Say I'm business A. I'll offer a portion of my business (say 40%) with the offer that you will reap 40% of my profit. (Assuming one person pays in for that whole value).(edit: I offer this as the income will allow me to expand where as otherwise I'd have to wait longer depending on profit)
At what point does almost anything else you mentioned help the business?
Everything else seems likes gambling, imho, and I still can't wrap my head around why it's allowed.
If you need $100m, it matters whether you're giving up 10% or 20% of the business for that money.
(A major benefit to the public of financial markets is diversified pension funds with good returns, btw)
*At what point does almost anything else you mentioned help the business?*
To create the market place, you must understand that different investors and different businesses have use cases that you don't need, such as "almost anything else" I mentioned.
*Everything else seems likes gambling, imho*
The reason why folks must be confused is that, non Stock market gambling is seen as a vice and/or crime by much of human society. There are religious edicts and/or laws against this practice in most places. The Stock Market getting a free pass from this view - and most people (including myself) not knowing about the nature of this system until they dig a bit deeper - seems unfair.
Las Vegas is looked upon as lascivious even when some of the gambling requires skill (Poker / Blackjack) - derivates trading is instead marketed as a great career where the people doing are superheroes.
I’m not bitter about this even if the message sounds so. Just fascinated by the asymmetry of perception.
Then I learned it's all about risk management and absolutely technical analysis trading is gambling. I agree with you, blew my mind!
Let's even suppose you're right, and it is only gambling -- why should it be disallowed?
The market (in general) rewards companies who show a prospect of increasing profits. In other words, they reward healthy company behavior the same way that a calendar would reward an effectively competing company or a biological entity (with continued survival and thriving).
It's an imperfect mechanism for sure, but in general, healthy companies get rewarded and unhealthy companies get pressure to become healthy or to die. I don't see that the problems outweigh the benefits.
This allows you, as a business, to not have to turn a profit and still be in business.
that's exactly what he said. to not have to turn a profit yet remain in business.
Once the stock has been released to the public, the market remains a valuable tool for the market to determine price, both among investors and for the company (buybacks and additional offerings primarily).
And this is just a simplified model of the equity markets. Add debt, derivatives, FX and various futures, and it gets more complicated.
Clear, transparent information about these prices and the ability to buy and sell this risk reduces overall costs to the economy for operating these ventures, greatly increases overall liquidity in the market, and overall greatly lowers overall costs and provides much more ready access to capital for ventures.
1. https://www.amazon.com/Time-Will-Back-Henry-Hazlitt/dp/16101...
Stock markets make it easy to sell your stocks- If you can't sell a stock it's just a useless piece of paper.
It makes it easy for an investor living in France to invest in a US tech company.
Just because you own an amazing company doesn't mean you want to keep your entire net worth in a single stock.
2. I would buy Apple shares if I could sell them at a moments notice. I wouldn't if I couldn't.
3. A liquid investment is generally valued higher than an illiquid one.
4. A higher valuation means the company is able to raise funding from the market at a later stage, by selling additional equity (if required) -- this is relevant for the company.
Plus, for more established companies: the prospect of regular dividends. That's not as much of a thing as it used to be, though.
I understand investing in companies, but for me, and I'll admit a completely naive person to this whole system, it seems to have taken an 'inbest in company with money to help them succeed', to a 'who cares let's just cut and run to make the best profit'.
I'm perfectly willing to take a link to a great explanation at this point btw.