A simplistic comparison of the stock market to an auction

A stock exchange is similar to an auction house. If you collected rare coins and saw that a leading auction house had coins to sell, you could attend the auction. You would compete with other interested buyers for the coins. The buyer who agreed to pay the highest price would acquire the coins.

Probably a bit more relevant to your everyday experience is when you buy something on eBay (NASDAQ:EBAY). With eBay, you can set the minimum and maximum you will pay for the item. As other bidders enter the market, they can bid against you with eBay's automatic bid tool until one of you reaches your personal maximum; the most that you think the item is worth. At that point, one bidder will be the current leader and others will have to bid against the leader.

At any time during the auction, an interested bidder on eBay could value the item more and increase the bid to be the leader. The winner of the item is the person with the largest bid at the end of the auction deadline set by the seller.

The stock market is larger and more efficient than eBay!

The auction example doesn’t quite hold for stock price, though, as there are no deadlines. Also, buyers may immediately become sellers. It is similar in that the stock price is set by the number of people who want to sell their shares at the current price and those who want to buy the stock at that price.

If an investor wants to sell shares of a company, he looks at the current share price and determines if it is in his best interest to sell the stock. If it is, he will sell it. If he needs a higher price to sell the shares to meet his goals, he will hold on to the stock. If no investors want to sell their shares at a given price, then no buyers will be able to buy shares. This will cause the price to increase until some investor somewhere thinks the price is high enough to sell.

The converse is also true. There are times when potential investors believe that a stock's price is too high to be a suitable investment. At the same time, there are shareholders who want to sell the stock. In this case, the price will go down until some investor wishes to buy the stock. Most stocks huge volume changing hands in any given day so there is little delay between the buying and selling of a stock.

This makes the market extremely efficient but a little chaotic. Every investor has a different way to analyze the company and determine if it is wise to invest. Also, every investor has separate outside influences in spending money, which includes other investment options. With the diverse range of influences and opinions of thousands or millions of investors, the market may be quite volatile. Prices can change a few percentage points each day on the most stable of days and move even farther on days when there is a significant amount of activity.

The good news for you, the individual investor, is that you do not need to understand all of this background theory. You simply need to understand that when you want to buy a stock you can buy it. The price may be better or worse tomorrow though so it is important to try to buy the stock at a discount. This is where my book, The Confident Investor, can help. You can purchase my book wherever books are sold such as Amazon, Barnes and Noble, and Books A Million. It is available in e-book formats for Nook, Kindle, and iPad.

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