I understand buy low and sell high, but then what?
If, say the S&P500, keeps growing there is no ‘peak’ to sell at. Do the gains compound? if so how? Or do you just hold it forever and sell when you want to get the money?
In: Economics
Too much jargon in the comments section. Let me take a stab at it.
Say I want to set up a company that manufactures and sells birthday cakes (keep in mind that me and the company are different legal entities). I’m willing to put up $1000. So what the company does is that it issues “shares”. Let’s say the company tells me that it’s issuing 100 shares to me, each worth $10. This is where it all begins. I’m running my little company, baking cakes at $1, selling them for $2, and making a nice little profit.
At this stage, I own 100% of the company. It’s entirely privately owned by me. Let’s say I need $1000 more to buy an additional oven and a store. I could either borrow the money or I could decide to sell the shares of the company. Let’s say I decide to sell the shares. I’ve done a lot of financial mumbo jumbo (valuation techniques) and I’ve arrived at a conclusion that each share of the company is now worth $50. I decide to sell 20 shares to a stranger and now I’m left with 80 shares (This is called and offer for sale). There is another way wherein the company could decide to issue 20 more shares and I’d still be left with 100 but the total shares would be 120 (this is called a fresh issue).
The catch here is that valuation techniques are subjective. For example, I decided that my company shares were worth $50 each. Another person could say they’re worth $30, and another could say they’re worth $70 (coz he thinks my company has potential).
With the basics out of the way, What happens in the stock market is that companies have gone through the process of issuing a lot of shares and there are people with shares, some who are looking to sell, some who are looking to buy. Let’s say a share is trading at $1000 in the market right now. Valuation is subjective, there is someone who says he’s willing to pay $1100 if anyone is willing to sell. No one sells. Another buyer who could potentially value the company at $1500 per share says he’s willing to buy at $1200. No one’s willing to sell. This process is basically how the price of a share rises in the market. You have buyers who are willing to pay more than what the share’s current price is.
It works exactly the opposite way when it comes to selling. And this subjectivity and willingness to buy / sell is what drives prices up or down.
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