The truth about the stock market - that you probably already know.
Last edited Fri Jan 8, 2016, 02:21 PM - Edit history (1)
First, what is the stock market? Surely that's an easy question to answer, yes?
Let's ask wikipedia for some basic definitions:
Stock Market: "A stock market or equity market or share market is the aggregation of buyers and sellers (a loose network of economic transactions, not a physical facility or discrete entity) of stocks (also called shares); these may include securities listed on a stock exchange as well as those only traded privately."
Stocks/Shares: The stock (also capital stock) of a corporation constitutes the equity stake of its owners. It represents the residual assets of the company that would be due to stockholders after discharge of all senior claims such as secured and unsecured debt. Stockholders' equity cannot be withdrawn from the company in a way that is intended to be detrimental to the company's creditors.
Securities: a security is a tradable financial asset of any kind.[1] Securities are broadly categorized into:
- debt securities, (e.g., banknotes, bonds and debentures)
- equity securities, (e.g., common stocks)
- derivatives, (e.g., forwards, futures, options and swaps)
Debenture: A debenture is ... like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the company's capital structure, it does not become share capital.
Derivatives: In finance, a derivative is a contract that derives its value from the performance of an underlying entity. This underlying entity can be an asset, index, or interest rate, and is often called the "underlying".[1][2] Derivatives can be used for a number of purposes, including insuring against price movements (hedging), increasing exposure to price movements for speculation or getting access to otherwise hard-to-trade assets or markets.[3] Some of the more common derivatives include forwards, futures, options, swaps, and variations of these such as synthetic collateralized debt obligations and credit default swaps.
Got it?
So, basically, all the stock market is, is people that invest in chunks of a company - the price of those chunks is based on the VALUE of the comapny. Or people place bets on the VALUE of things changing. It can also be things like buying debt when the comapny is in trouble with the plan of selling it when it's not, or vice versa, or other forms of derivatives, which are, again, based on the VALUE of a company.
You see, at the end of the day all of this - the price you pay for stock, the price you pay for debt or of how much people guess something will rise or fall - all of these figures go back to one simple idea: the value of a company.
So.
How are companies valued? Is there a rational way to do such a thing, so that you know the value is meaningful?
Turns out, not so much:
"According to one interpretation of the efficient-market hypothesis (EMH), only changes in fundamental factors, such as the outlook for margins, profits or dividends, ought to affect share prices beyond the short term, where random 'noise' in the system may prevail. (But this largely theoretic academic viewpoint—known as 'hard' EMH—also predicts that little or no trading should take place, contrary to fact, since prices are already at or near equilibrium, having priced in all public knowledge.*) The 'hard' efficient-market hypothesis is sorely tested and does not explain the cause of events such as the crash in 1987, when the Dow Jones Industrial Average plummeted 22.6 percent—the largest-ever one-day fall in the United States.
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*It's worth pointing out that Hard EMH - if true, which basically says that the true value of a company is based purely on it's tangible assets and all publicly available financial metrics, would mean that the closer we are to understanding a companies true value, the less people will trade it's stocks, as it's price can't change, because no underlying information has changed. Compare that to reality, and all that that implies.
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This event demonstrated that share prices can fall dramatically even though, to this day, it is impossible to fix a generally agreed upon definite cause: a thorough search failed to detect any 'reasonable' development that might have accounted for the crash. (But note that such events are predicted to occur strictly by chance, although very rarely.) It seems also to be the case more generally that many price movements (beyond that which are predicted to occur 'randomly') are not occasioned by new information; a study of the fifty largest one-day share price movements in the United States in the post-war period seems to confirm this."
Other research has shown that psychological factors may result in exaggerated (statistically anomalous) stock price movements (contrary to EMH which assumes such behaviors 'cancel out'). Psychological research has demonstrated that people are predisposed to 'seeing' patterns, and often will perceive a pattern in what is, in fact, just noise. (Something like seeing familiar shapes in clouds or ink blots.) In the present context this means that a succession of good news items about a company may lead investors to overreact positively (unjustifiably driving the price up). A period of good returns also boosts the investors' self-confidence, reducing their (psychological) risk threshold.[36]
Another phenomenon—also from psychology—that works against an objective assessment is group thinking. As social animals, it is not easy to stick to an opinion that differs markedly from that of a majority of the group. An example with which one may be familiar is the reluctance to enter a restaurant that is empty; people generally prefer to have their opinion validated by those of others in the group.
In one paper the authors draw an analogy with gambling. In normal times the market behaves like a game of roulette; the probabilities are known and largely independent of the investment decisions of the different players. In times of market stress, however, the game becomes more like poker (herding behavior takes over). The players now must give heavy weight to the psychology of other investors and how they are likely to react psychologically.
I'll just c+p that again, to make sure you caught it:
"It seems also to be the case more generally that many price movements (beyond that which are predicted to occur 'randomly') are not occasioned by new information; a study of the fifty largest one-day share price movements in the United States in the post-war period seems to confirm this."
In normal times the market behaves like a game of roulette; the probabilities are known and largely independent of the investment decisions of the different players. In times of market stress, however, the game becomes more like poker (herding behavior takes over). The players now must give heavy weight to the psychology of other investors and how they are likely to react psychologically.
So putting aside the random stuff, prices change all the time based on ----- nothing. Literally no one has ANY IDEA WHY. In fact - in case you missed it - the single largest one day stock market fall in US history is STILL UNEXPLAINED.
And guess what, it's only getting worse.
LOTS of people think we're living through another tech bubble. Many times in a stock bubble prices are based PURELY on predictions of FUTURE VALUE of a company.
Look at a RELATIVELY mature company like Facebook. It makes BILLIONS in profits - apparently - and is valued at between 200 and 300 BILLION dollars, but why?
Last year it 4 Billion in revenue - remember it's "worth" 50-75x more than that, but 99% of it's profits came from... selling ads. And in fact "net income declined by almost 10% to $719 million".
Some people are saying that FB is WILDLY overvalued... a pretty calm version of that is this:
"Having now re-assessed Facebook, I see my gut was right. Unless and until FB asserts itself with some new revenue streams, I’m not comfortable buying into a narrowly-diverse pure-play advertiser.
As far as valuation, I can’t say it’s unreasonably valued. I give FB a 10% premium for its brand name, and free cash flow — all on analyst estimates of 27% long-term growth. However, fair value is about $66 — about 30% lower than current prices."
So there's a investor, not a scaremonger saying that Facebook is probably worth about 30% less than the market thinks.
That's 30% of aprox 270 Billion dollars. That's the kind nonsensical margin or error the stock market works on.
And that's because there is NO REAL WAY TO VALUE COMPANIES ACCURATELY. And VALUE is based PURELY on what people THINK it's worth.
Chinese investors have been hearing doom about their market for years now, and are finally believing it. Particularily the hyper rich, who are dumping Chinese stocks as fast as possible. It seems the more you know about Chinese stocks, the less you want to have your money in them.
But that behaviour - selling based on fear - or optimism - is the MOST COMMON reason HUMANS move their money around in the stock market.
However, the US stock market is not really run by humans any more at all.
Some estimates say that almost 9/10 trades on the US and UK market are now done automatically by computers, based on some clever algorithms.
That's right, humans barely trades stocks at all any more. The floor of the NYSE is largely just a TV set.
But these robot traders aren't cold and logical, they're actually frequently used to cheat and distort the market:
"Eric Hunsader from US data firm Nanex believes robot traders fiddle the market, ordering then cancelling trades just before the critical buying moment. “If the regulator fully understood what the computerised trader was doing, it wouldn’t be legal,” he told World Finance."
You see, companies use their robotic traders to help them squeeze extra money out of the market. The regulators have LITERALLY no idea how most of these companies use this technology and as such, the market is, largely rigged.
I said you probably already know this, because Americans can EASILY see the Stock Market has fully decoupled from every other economic indicator. Stock prices drop 10% on the same day the US government announces 300K new jobs being added to the economy. Why?
Because some American computer software somewhere based decisions on something happening - which was based on fear and government manipulation - in China, because the stock valuations there - like here - are completely fictional.
Aren't you glad so many American's have their pensions invested in the market?
"Last week's wild gyrations in global financial markets almost certainly exposed the vulnerability of U.S. state and local authority public pension funds which have piled into riskier assets in recent years, according to actuaries and other pension experts.
Based on data from the Federal Reserve, the funds are sitting on nearly $4 trillion in assets that are more than 70 percent exposed to equities and other riskier assets, such as commodities and hedge funds. And some states with massive pension funding deficits, such as Illinois, are likely most in danger of suffering big losses given their risk profiles.
Since the financial crisis, many public pension funds have increased their exposure to hedge funds and other higher-risk assets to meet ambitious investment return targets. Most funds assume a rate of return of 7-8 percent a year, according to a May report by the National Association of State Retirement Administrators. Those assets can also take a big hit when equity and related markets plunge.
At the same time, they have cut back on safer assets, such as U.S. government debt and other lower-risk fixed income investments, which are not expected to provide big returns in the next few years."
More on Pensions:
http://www.reuters.com/article/us-usa-pensions-selloff-idUSKCN0R144Q20150901
Robots on Wall St info:
http://www.worldfinance.com/home/robots-are-killing-off-wall-streets-traders
http://www.motherjones.com/politics/2013/02/high-frequency-trading-danger-risk-wall-street
http://www.zerohedge.com/contributed/2012-17-26/84-all-stock-trades-are-high-frequency-computers-%E2%80%A6-only-16-are-done-human-tra
http://www.worldfinance.com/home/robots-are-killing-off-wall-streets-traders
Some FB info:
http://investorplace.com/2015/08/facebook-stock-fb-future/
http://finance.yahoo.com/q/ks?s=fb+Key+Statistics
Links to most of the wiki quotes - and some of the quoted text in this post - can be found here:
https://en.wikipedia.org/wiki/Stock_market
= new reply since forum marked as read
Well... it could be argued they add value to their company... lol.
They bring as much value to eg Apple as a car salesman does to your eg Prius. 
And like you point out, they actually LOSE money for millions of people, relative to index funds...
Of course, the endless sales of specific stocks/funds/etc., by informercials like CNBC will artificially raise the value of some things eg Facebook got a HUGE media bump, but those values are again completely nonsense. If you DO manage to luck into a stock that blows up, and then sell it before people freak out and it collapses, you can make money, but that... as a basis for the pensions... is extremely stupid and dangerous... and as a basis for the economy, is suicidal.
And of course none of this even begins to address the ENDLESS corruption in the markets.
