Price Declines Aren’t Caused By Selling
I was reading “The Number” the other day, which is a great account of stock market history and distortions in the 20th century, and I noticed that it described the crash of 1929 by saying “the market was overwhelmed with sellers”. This is how we usually view things: when lots of people sell a stock the price goes down, and when lots of people buy it the price goes up. This is wrong. If you sell a stock, someone has to buy it. If you buy a stock, someone has to sell it. So on any exchange on any day the number of shares sold is exactly the same as the number of shares bought.
If this is true (it is) how do prices go up and down? This is purely a reaction to the thoughts and willingness of investors and traders. Let’s say I own a share of Blackberry and you don’t. I’m interested in selling it and you’re interested in buying it. I won’t sell it for anything less than $15, and you won’t buy it for anything more than $14. Clearly we can’t make a deal here.
Now let’s say Billy-Bob also owns a share of Blackberry. Initially he’s like me, but then he gets food poisoning and suddenly decides that the future prospects aren’t so bright. He’s willing to sell his share for as little as $13 now. You buy his share and you both walk away happy that you got a good deal.
So a more accurate description of how prices go down would be more like this (I’m sure it’s still not the literal truth). At first there are buyers and sellers in the market who can agree on a price, so they trade. After enough of these trades those buyers and sellers leave the market because they got what they wanted. Now the only buyers left in the market are unwilling to pay the previous price. Seeing this, some of the remaining buyers start to leave and the price that sellers have to accept to make a deal goes down. Soon a few sellers decide that they are willing to accept that, so they make a deal with the remaining buyers. Other buyers see this and say “hey, I’m not paying this much if prices are on the way down!”. Once again the demand shifts to a lower price. The most desperate sellers agree to this price so the stock continues to go down.
This keeps happening until buyers get less demanding or sellers get less desperate. Any time there is a gap the sellers can close it by accepting a lower price or the buyers can close it by accepting a higher price. The price of the last trade is what gets reported so we always see the effect of the least demanding buyers and sellers. But that trade was based on one share being sold and bought. We can never say that “today 200,000 shares were sold but only 100,000 were bought, driving the price down”. The number of trades on any day does not determine the direction of the price. All that changes is that people decide they are suddenly willing to accept more or less than yesterday’s price even though they weren’t interested in that yesterday.