Supply and Demand in Action
With the emphasis on charting and other technical indicators having nothing to do with economic factors, it is easy to ignore the hard realities. The Dow Jones Averages do not measure any economic influences, nor are they based on anything except unweighted prices in a few stocks. We have previously detailed the problems of the Dow Jones Averages. However, the averages are so widely depended on and reported, and they are recognized as "the market." Therefore, the very important influences of supply and demand may be overlooked.
Most people understand the basic theory of supply and demand. However, a brief and simplified review is in order. As demand grows for a particular stock, its price is forced upward and, as demand is lowered, prices will fall. This generalized observation of the economics of the market applies in virtually all free markets, from grocery stores to auto lots to appliance outlets. But what is less understood is the reason for changing levels of demand. Why do people suddenly want to buy a particular stock, and of equal interest, why do people want to sell?
rKEY POINT
You might understand the theory of supply and demand, but knowing about the nature of these changes is rather mundane. We know the answer to the question: What is demand? A more interesting question is; Where does it come from?


Following are a variety of apparent reasons, and a few not so apparent ones, why demand for a stock fluctuates.
Institutional investors have a lot of influence. Remember that the majority of trade volume on the public exchanges is the result of institutional trading (mutual funds, etc.) and only a small portion consists of individual traders.
Forecast results do not always come to be. Great reliance is placed on professional analysts' forecasts. The entire theme of the market is speculation about what the future will hold. If a forecast is not met, even though returns may be acceptable, some investors decide to sell.
Rumor and speculation are taken seriously in the market.
You may understand the theory of supply and demand quite well. But after observing the market for a while, you will come to see that rumor and speculation count for much more than fact.
The herd mentality makes the market irrational at times.
When a mass of people come to believe something, even if it is not true, they all act as though it is true. So they may buy or sell based on that belief.
rKEY POINT
You may be frustrated by the illogic of the herd mentality. However» it should be enough to observe it and to learn from it without giving in to its influence. This is a valuable form of market intelligence.


Fundamentals, while respected, are pushed aside when more appealing arguments are available. A certain financial position and financial results are factual data, especially when confirmed by independent audit. If you ask fellow investors or read what professionals say, virtually everyone has great respect for the fundamentals. But the actions of the market are based on less rational information, and on factors having no economic base.
Some historical changes in supply and demand have been entirely irrational, even hysterical. You can learn a lot about the modern stock market by looking at historical examples of market irrationality. The most extreme has to be the seventeenth century events in Holland concerning the market for tulip bulbs.
Rumor and speculation are taken seriously in the market
You may understand the theory of supply and demand quite well. But after observing the market for a while, you will come to see that rumor and speculation count for much more than fact.
The herd mentality makes the market irrational at times.
When a mass of people come to believe something, even if it is not true, they all act as though it is true. So they may buy or sell based on that belief.
rKEY POINT
You may be frustrated by the illogic of the herd mentality. However, it should be enough to observe it and to learn from it without giving in to its influence. This is a valuable form of market intelligence.


Fundamentals, while respected, are pushed aside when more appealing arguments are available. A certain financial position and financial results are factual data, especially when confirmed by independent audit. If you ask fellow investors or read what professionals say, virtually everyone has great respect for the fundamentals. But the actions of the market are based on less rational information, and on factors having no economic base.
Some historical changes in supply and demand have been entirely irrational, even hysterical. You can learn a lot about the modern stock market by looking at historical examples of market irrationality. The most extreme has to be the seventeenth century events in Holland concerning the market for tulip bulbs. A market appeared of institutional trading (mutual funds, etc.) and only a small portion consists of individual traders.
Forecast results do not always come to be. Great reliance is placed on professional analysts' forecasts. The entire theme of the market is speculation about what the future will hold. If a forecast is not met, even though returns may be acceptable, some investors decide to sell.
Rumor and speculation are taken seriously in the market.
You may understand the theory of supply and demand quite well. But after observing the market for a while, you will come to see that rumor and speculation count for much more than fact.
The herd mentality makes the market irrational at times.
When a mass of people come to believe something, even if it is not true, they all act as though it is true. So they may buy or sell based on that belief.
rKEY POINT
You may be frustrated by the illogic of the herd mentality. However, it should be enough to observe it and to learn from it without giving in to its influence. This is a valuable form of market intelligence.


Fundamentals, while respected, are pushed aside when more appealing arguments are available. A certain financial position and financial results are factual data, especially when confirmed by independent audit. If you ask fellow investors or read what professionals say, virtually everyone has great respect for the fundamentals. But the actions of the market are based on less rational information, and on factors having no economic base.
Some historical changes in supply and demand have been entirely irrational, even hysterical. You can learn a lot about the modern stock market by looking at historical examples of market irrationality. The most extreme has to be the seventeenth century events in Holland concerning the market for tulip bulbs. A market appeared suddenly for rare tulips and many people were able get rich in the short term by speculating in those bulbs, not only in Holland but in other European countries as well. As activity increased, more and more people came into the market, driving prices up. Greed took over. Historian Charles Mackay in 1841 noted that in Extraordinary Popular Delusions and the Madness of Crowds:
... it was deemed a proof of bad taste in any man of fortune to be without a collection of [tulip bulbs] ... The rage for possessing them soon caught in the middle classes of society, and merchants and shopkeepers, even of moderate means, began to vie with each other in the rarity of these flowers and the preposterous prices they paid for them.
As it always happens in such situations, the bottom fell out of the market without warning. Bulbs worth four thousand florins fell quickly to three hundred, and even at that price, no buyers could be found. Fortunes were ruined.