In a prior post, I discussed the need for a theory of the markets. In this post, I want to discuss my view of the meaning of price.
I believe that price is an entirely psychological phenomenon. Something is worth only what someone else is willing to pay for it. The price that someone is willing to pay depends only on their own sense of a particular item’s value and worth. If a particular potential buyer believes that a particular price is reasonable or low or high or ridiculous, that will affect the willingness of that buyer to transact at that price. The idea of a “bargain” exists only in the head of prospective buyers. If someone thinks a price is low then they will be more willing to buy at that price than if they think the price is high.
Note that there is no objective measurement of pricing reality here. Only the perspectives inside the heads of the prospective buyers and sellers matter. Buyers generally want to buy when they think the prices are “low,” “bargains,” or “good values.” Sellers want to sell when the prices are “high,” “overpriced,” or “expensive.”
If I want to sell 1,000 shares in a particular stock or 5 contracts of a particular futures contract, it only matters if I can find at least one buyer willing to purchase from me at a price that I am willing to sell. With modern electronic markets, it is generally very easy to figure out if this is the case, I need only look at the current bid and ask prices.
So what changes price?
Many people think that prices rise when there are more buyers than sellers. This is wrong. Prices don’t rise because there are more buyers than sellers. For any given transaction, there is one buyer and one seller. This is true when the price goes up and when it goes down. When an exchange lists trading volume for a given market for a day, that volume represents an equal number of buyers and sellers. So if prices don’t rise because there are more buyers than sellers, what does cause them to rise?
Prices rise when buyers are more anxious than sellers. When they are anxious, buyers are willing to pay a higher price in order to make a purchase. When sellers are willing to stick to their price and buyers are willing to pay more, this will result in a rise in prices. More anxious buyers, plus relatively less anxious sellers results in rising prices.
Prices drop when the reverse happens, when sellers are more anxious than buyers. When they are anxious, sellers are willing to sell at lower prices in order to transact a sale. If there are no buyers willing to buy at the current asking price, then the sellers will have to lower their asking price to find a buyer. This results in a price drop.
So what affects the relative anxiety of buyers and sellers? That’s a good question and the subject for a future blog post.
Trading From Your Gut
Way of the Turtle
Inside the Mind of the Turtles