Edition One

More Investing Information • The Rule of 72 • How to Become Wealthy • Investing 101

Related Resources • Coffee Talk 1 • Coffee Talk 2 • Coffee Talk 3 • Coffee Talk 4

Question: How is Stock Price Determined?

Joshua:

I have a question. What exactly is it that drives a stock price. Who decides what a stock sells  for? The company, the traders, or the SEC, ect. I am a little confused about that. I realize the more people buy the higher price goes and when alot of people sell it goes down but what are the mechanics of it?

Thanks for your help,

Mike B.

Answer

Mike,

Okay... a quick illustration of how stock price is determined.  Remember the Beanie-Baby phenomenon a few years ago?

Say there is one Beanie Baby in the entire world.  It is small, it is cute, and it is a pale shade of blue.  Now picture 30 teenage girls who each have a lot of money in their pockets.  They all meet around a giant oak table and the girl who owns the Beanie Baby announces to everyone she is going to sell it... now keep in mind, there is only one of this particular kind in the world, and it is incredibly rare.  Of course every girl at that table wants to own it, regardless of what it costs them.  So they all start screaming out what their willing to pay.  One offers $20, another $40, and another $45... eventually it reaches the point where a very snobby, rich girl from New England offers $250 for the Beanie Baby.  She wins the auction and takes the doll.   Then, five minutes after she does, a young man from England shows up with a box of 40 Beanie Babies that are exactly the same as the one the girl just bought [so now there are a total of 41 Beanie babies... and only around 30 girls]  Suddenly, the girl panics and tries to sell the $250 Beanie Baby she just bought... but the problem is, no one wants it!  She offers it at $250... then $200... then $100... then $50... and finally, for $19.95 she sells it to a very stupid girl from Deluth who doesn't realize that there are now a lot of the exact same doll out there and it is now worthless.

Now... turn the girls into old men wearing expensive suits sitting in the middle of the New York Stock exchange.  That's EXACTLY what investing is. These people take stocks [or literally the right to own part of a company] and buy and sell them based on what they "think" it is worth.  It is the same thing as when you go to a charity auction and an old table or lamp is auctioned off.  Completely the same thing.

The SEC is responsible for catching fraud and making sure that companies tell their investors how their balance sheet looks... they are there to stop
the small guy from getting cheated.  They have no control over prices.  Hope to hear from you again.  Be sure to go to
http://beginnersinvest.about.com and join the free newsletter!!!

Peace,
Joshua Kennon
http://beginnersinvest.about.com

Question: What does SMA Value mean?

I have an account with Ameritrade and there is a thing they call "SMA Value" listed.  I can't find out what it is; I have not talked to Ameritrade yet.  Can you give me a definition?

Thanks,

A Reader

Answer

SMA stands for "Special Memorandum (Miscellaneous) Accounts" and deals with buying on margin [which is not generally a practice that I would recommend if you want to sleep at night].  Here is a web page that discusses SMA Value.

Joshua Kennon