The Commodity Nature of Stocks

One of the elements that contribute to the fluctuation in stock prices is the nature of the stock market itself. In lesson one, I explained the stock market is, at its core, "a large auction where ownership in various companies is up for sale to the highest bidder." Since there are only a set number of shares available at any given time, any buying activity will drive the price of these shares up. Selling will drive share prices down.

In this respect, stocks are no different than a commodity such as oil. They are subject to the same laws of supply and demand. When there are more shares available than demand, each of those shares is worth less. The opposite is true when there is more demand than shares available. This explains why institutions and very wealthy individuals build up positions1 in their favorite stocks slowly. If someone wanted to buy several million dollars worth of stock in a company and they simply placed on massive order with their broker [this is known as a block trade2], the stock price would skyrocket because there wouldn't be enough shares available at the time to fill the order. The same is true when a wealthy individual or institutions wants to sell a large chunk of stock in a company. If they were to dump them on the open market all at once, there would not be enough buyers to buy the stock they were selling. This would cause the stock to immediately tank, wiping out huge amounts of market capitalization, even though the underlying economics of the company haven't changed.

^{1 When someone is said to be "building up a position" it means they are slowly accumulating shares in a company. 2 A block trade is generally considered to be anything over $100,000 or 10,000 shares.}

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This page is part of Investing Lesson 2 - What Makes Stocks Become Over or Under Valued. If you have already read this lesson, you can skip directly to the Investing Lesson 2 Quiz.