How to Understand Demand for Securities - dummies

How to Understand Demand for Securities

The standard economic law of supply and demand doesn’t apply to securities. The creation of demand for securities more closely resembles an auction. So, in securities trading, the pricing process is like the pricing process in an auction:

  • Prices move very quickly.

  • Demand for the item often rises as the price rises.

In an auction (whether live or online), what gets your blood running is that someone else also wants to buy the item in question. Visible demand begets more demand. In the auction situation, demand increases while the price rises. The item may or may not be actually scarce in the real world. It doesn’t matter.

The immediacy of the auction is what skews prices, sometimes to absurd levels. Later, when suppliers see the high prices, they may indeed be able to find or produce more of the item — but by then, the specific demand dynamic of that one auction is gone.

In technical trading, think of the supply-and-demand relationships like this:

  • Demand for a security rises on rising prices, not falling ones.

  • The supply of a security dries up on rising prices, at least in the short run. (Later, when the long-term security holder sees how high the price has gone while he wasn’t looking, he may say “Holy Toledo!” and call his broker to sell, making more supply available.)

Aside from getting a dividend or coupon payment, the only reason to buy a security is to make money off it or sell it again, preferably for more than you paid for it:

  • As an investor: You may buy stocks and bonds chiefly to get the dividend or the interest rate coupon, with capital gain on the price a secondary consideration.

  • As a trader: You buy a security because you think the price will rise. You decide to sell because you have a profit that meets your needs or because you have taken an intolerable loss. You seldom think about the true supply of the security.

While, technically, the supply of any security is limited by the number of shares outstanding and the like, supply may be considered infinite for all practical purposes. If you really have to have 100 shares of Blue Widget stock, some price you can offer will get you those shares. Turn it around, and you can easily see why. A price exists at which you can be induced to sell the stock for which you paid $10. It might be $20, or $200, or $10,000 — but rest assured, some price will force you to part with it, and right now.