Principles of the investment market

(Jeff puckering) #1

Hoping this can be a safe topic for newbies to investing (like me) to ask some basic questions about the principles and rules regarding investing. Assuming there will be some friendly more educated people willing to help!

First one to throw out there, can shares in companies be ‘out of stock’ so to speak?

If company x has 10,000 shares available on the stock market what happens when share 10,000 is sold and there is no one selling?

I’m guessing this has to be true as it wouldn’t be trading. But what does this mean for etf or tracker type funds?

Hope this doesn’t seem too basic but happy to embarrass myself for education!

(Vladislav Kozub) #2

When companies issue new shares (happens rarely with public companies) - yes. This is quite similar to Crowdcube - if Freetrade says “we will raise up to £3.1m” - that is the limit you have and all shares will be sold at the advertised price (54p for Freetrade for instance).

However, all the shares on the stock market (Amazon, Netflix, Apple, Google, etc.) are sold by shareholders to potential (new or existing) shareholders. The company in question has absolutely no interaction there (unless they arrange buybacks, but that does not happen too often either and only increases the share price which is good for existing shareholders). So the answer is No, they cannot be out of stock.

Once they are sold out (at the IPO for instance, like Spotify did recently), they will be traded on the market by general investors (either individuals or institutions).

Once that 10,000 is sold by the actual company who issued shares, they continue trading and never leave the market, unless the issuer company buys them back and eliminates.

Whilst being traded on the market, ETFs will buy them at a current market price whenever you place an order to buy an ETF. If you (and others) buy so many so that the demand will be in excess of supply - the prices will rise to stimulate more selling (which is human’s nature, to sell when it went up a bit)

This leads to supply/demand aspect. In a nutshell, stock markets (NYSE, NASDAQ, LSE, etc.) buy and sell shares to investors (like yourself) on demand/supply matching basis.

Whenever demand price (when you want to buy) matches the supply price (when someone wants to sell it to you) - that is where the market price is established and the transaction was made.

For example, let’s say you hold Applepear and will not sell it for less than £110. The most expensive buyer wants to get it for £90. Unless you (or any other) seller will reduce the price to £90, the share will not be bought.

But that is in very simple terms. Of course, the figures in real life a very close, the supply/demand price differences are measured with pence and cents.

Therefore, if a big guy like Viktor comes in and buys 10,000 cheapest Applepear shares from our example, he will buy yours at £110, then you neighbour’s at £120, then 500 other people’s Applepear shares and the market price will inflate due to a huge excess in demand. It may even end up being £300. And then you will cry you sold yours and did not stay the course. And then whoever owns the 10,001th cheapest shareowner will say “nah Viktor, I will only sell at £310 now”.

So when you see Amazon’s 10000% growth in the last 20 years, it basically means that investors keep selling shares at higher and higher prices, inflating the share price. And the demand keeps increasing, as people have faith in further growth so that they can then cash in at some point as well.

P.S. Let me know if I was unclear at any point. I did my best being informal and giving simple examples but could have slipped somewhere :grinning:

(Jeff puckering) #3

Thanks! Really appreciate the in depth answer.

How does this look in practise? Is it always the case that a stock is sold often enough to fulfil a buyers request, can it be the case that your locked out of buying a stock for a period of time until one is sold? If so do you state what your willing to pay, then if demand is so high is it first come first serve?

Thanks again!

(Vladislav Kozub) #4

The ETF itself is not a stock but a basket of various stocks. Let’s say you want to buy an $APLPOBA ETF which contains 50% shares of Applepear and 50% shares of Orangebanana. When you buy 1 piece of that ETF, the ETF management will have to get 0.5 shares of Applepear and 0.5 shares of Orangebanana for you. At their current prices (it could be 1, 0.3, 0.01 - does not matter, but the less shares they buy, the cheaper the tracker is. We will assume 0.5 for each).

So if Applepear is £300 and Orangebanana is £100, the cost of the ETF will be £200 (0.5 of Applepear and 0.5 of Orangebanana) and the growth/fall in price of your ETF will depend on the performance of both of the companies within an ETF.

The supply will never disappear, it can only become cheaper or more expensive depending on supply/demand ratio. UNLESS the company in question goes into liquidation or stops being traded for any other reason (e.g. being acquired by someone else). In case of the former you are most likely to lose all of its value and in the latter you will be paid in cash for your stake (your opinion will not be asked whether you are happy to sell).

If you hold Applepear ONLY (as a separate company) and it goes into liquidation, you essentially lose everything.

If you have that lovely ETF, you will still have the value in Orangebanana. This is how ETFs mitigate your risks, so that even if any of the assets in an ETF goes to 0, you will have others to compensate.

Of course, real ETF or Index Trackers have many more companies, not just 2. S&P 500 would have 500 companies so a liquidation of one will almost be unnoticeable.

Which is why you must diversify and not keep all your eggs in one company.