9. What is the Stock Market
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In Unit 3, Lesson 1, we learned what a stock market is. Although many people might not view a stock market the same way as a food market, they’re actually more related than you might think. Like any market, in order for a trade to occur, there always needs to be a buyer and a seller. When sellers outnumber the buyers, the market is considered a buyer’s market. This means that the buyers are the ones that are moving the market price of the stock. But when the buyers outnumber the sellers, the market is considered a seller’s market. This means that the sellers are the ones moving the market price of a stock.
The selling and buying of 1 share, leads to the methods investors use to conduct trades. We first learned about a stop order. Here’s information for the securities exchange commission on the proper understanding of a Stop Order:
A stop order, also referred to as a stop-loss order, is an order to buy or sell a stock once the price of the stock reaches a specified price, known as the stop price. When the stop price is reached, a stop order becomes a market order. A buy stop order is entered at a stop price above the current market price. Investors generally use a buy stop order to limit a loss or to protect a profit on a stock that they have sold short. A sell stop order is entered at a stop price below the current market price. Investors generally use a sell stop order to limit a loss or to protect a profit on a stock that they own. Before using a stop order, investors should consider the following:
Short-term market fluctuations in a stock’s price can activate a stop order, so a stop price should be selected carefully. The stop price is not the guaranteed execution price for a stop order. The stop price is a trigger that causes the stop order to become a market order. The execution price an investor receives for this market order can deviate significantly from the stop price in a fast-moving market where prices change rapidly. An investor can avoid the risk of a stop order executing at an unexpected price by placing a stop-limit order, but the limit price may prevent the order from being executed. Some brokerage firms have different standards for determining whether a stop price has been reached. For these stocks, some brokerage firms use only last-sale prices to trigger a stop order, while other firms use quotation prices. Investors should check with their brokerage firms to determine the specific rules that will apply to stop orders.
The next type of order is a limit. Here is the definition and example from the securities commission:
A limit order is an order to buy or sell a stock at a specific price or better. A buy limit order can only be executed at the limit price or lower, and a sell limit order can only be executed at the limit price or higher. A limit order is not guaranteed to execute. A limit order can only be filled if the stock’s market price reaches the limit price. While limit orders do not guarantee execution, they help ensure that an investor does not pay more than a pre-determined price for a stock.
Example: An investor wants to purchase shares of ABC stock for no more than $10. The investor could place a limit order for this amount that will only execute if the price of ABC stock is $10 or lower.
As buyers and sellers move the market price of a stock through the use of these orders, the market will offer great deals or very expensive prices. This idea is represented by Benjamin Graham’s Mr. Market. Graham used the idea of Mr. Market to represent a stubborn business partner that sometimes offers great deals or horrible prices. Your job as an intelligent investor is to determine which deals are of great value. Don’t worry, if you stick with the lesson plan here at Buffett’s Books, you’ll learn the methods of Warren Buffett and Benjamin Graham.
