Supply and Demand
The Important Factor
That Moves Stock Prices
Supply and demand is an age old factor in economics. Most of us have studied this in school. However, when it comes to investing or trading the stock market, many forget this basic factor.
Those who forget that it is supply and demand that moves stock prices risk losing their money. Therefore, it is wise for us to take a look at this important factor.
Keep your analysis of supply-demand as simple as possible
Take a look at the above chart. Looks familiar? Most of us would have seen this chart before. There are numerous other complicated charts that we have seen in economic textbook.
Well, for our purpose, we don't need to look at all those complicated charts. The good news is, you only need to know the most basic of supply and demand. Trust me, you don't need to be an economist to make money in stocks. Just keep it simple.
How does supply and demand affect stock prices?
Although it is simple, there are still many who do not pay attention to it. Knowing something does not mean that you will put it into practice. So, make sure you not only know how supply and demand affects stock prices, but remember it always when you invest or trade.
Here is what you need to know...
When demand is increasing, stock prices will go up
Why does the price of one stock increases while another drops? Well, the simple answer is...because there is a lot of demand for it. Here is a simple and funny analogy to help you understand why stock prices go up.
I want you to imagine that there are 3 cookies in your hands. Imagine also that these 3 cookies are the last cookies that you have. They also happen to be the tastiest and crunchiest cookies in the world.
There are 3 people who wants to buy your cookies and each one is willing to pay you a dollar for those 3 cookies.
Suddenly, another 3 persons come into your shop and the 6 of them starts to fight for your delicious cookies. One of them starts to offer you 1.50$ for those three cookies. Then another offers you 2.00$ for those three cookies.
All of them just love your cookies so much and they start to bid higher and higher just to get them. And before you know it, the last bid is now 6.00$ for those three cookies.
Well, that is a silly stories. But that is also how the stock market operates. When there is a great demand for the stock, the price of the stock will go up.
When demand is decreasing and supply is increasing, stock prices will go down
Let us return to the earlier analogy. Now, imagine that suddenly 2 persons out of the 6 leave the shop. You will now have only 4 people fighting for those three cookies. So, there is now less demand for your cookies.
Guess what, one of your customer starts to say that 6.00$ for three cookies is too expensive. The others also seem to agree with her and refuses to pay 6.00$ for those cookies. She then asks you to lower the price. She offers you 4.00$ for those cookies.
Well, since there is less demand now(demand decreasing), you reluctantly agreed to sell your three cookies for 4.00$. Suddenly, your assistant comes out with a whole tray of cookies(supply increasing). Your customer sees it and then say to themselves...
Why should we be paying 4.00$ for those three cookies? There are lots of them now. So, they start asking you to sell them your cookies at the orginal price of 1.00$ for three cookies.
Well, the same also happens to stock prices. When demand decreases and supply increases, the price of the stock will go down.
A silly story, but stock market players can be more silly
I guess you might be shaking your heads at those silly people who would buy those cookies at such a high price. The truth is, THIS IS WHAT HAPPENS IN THE STOCK MARKET.
If you are not careful, you might just become the next person to get caught in a speculative mania. History has shown us that market crashes happen because great demand pushed up the prices of stocks to unreasonable levels.
We see this again and again. In 17th century Holland, we saw how people are willing to buy tulips for as high as 1200 florins before the market crashed. This was equivalent to the cost of 10000 pounds of cheese or 120 sheep!
We also saw the same thing happen in The South Sea Bubble where the stock price of South Sea Company unrealistically shot up to 1000£ before it collapsed. And of course most recently in 2000 where the Tech Bubble Burst.
Your job as an investor or trader is to know when supply and demand is increasing or decreasing
As an investor or trader, you will make money when you can determine when supply and demand is increasing or decreasing. This is where fundamental analysis and technical analysis comes in.
When you combine technical analysis, fundamental analysis and the other analysis which we will touch later, you will be able to know when is the best time to enter and exit a stock.
That's all for supply and demand. See how simple it is...
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