What makes the stock market so alluring is how simple it is.
You can, with a few clicks of a button, buy and sell shares of stock in a company in seconds. When you place an order, it goes out into the market and waits to be filled (or not) on your terms.
And when you buy shares of stock, you are buying a (very) small piece of a publicly traded company. Your hope is that the company will do well, the share price will increase, and the value of your investment will grow. Sometimes, if the company does not perform well, the stock price may fall, and the value of your investment falls with it.
Simple enough, right?
Except it is not nearly that simple. That is why you will hear stories about a company suffering a loss but the stock price jumped!
The price of stock is all about expectations. It's about what the market expects the company to do in the future. Stock prices jump or fall wildly when these expectations aren't met—when investors are surprised by events. This is why you'll see big changes in the stock price that don't seem to match the story.
Even if you consider all those factors, that is just one piece of a vast puzzle. And it's that complexity that keeps so many people on the sidelines—why it's so hard to get started in investing.
Today, we're going to talk about one of the participants of a trade—the buyer of stock. For every transaction, there is a buyer and a seller who believe two different stories.
And for every individual who thinks a stock is overpriced or the future looks bleak, the market finds another one who believes a completely different story and is willing to put their money behind it.
If you are selling a stock, why is there always a buyer?
Why is there always a buyer?
Most of us trade stock using an online broker app or website. You get the largest market with the greatest number of participants when you are buying or selling stocks during the regular trading day.
These days, computers and complex trading algorithms handle much of the order execution process once you click the sell button. In some cases, your broker sends your shares to the exchange floor where a “market maker” buys your shares and then works on finding a buyer.
Most stocks and ETFs trading on the New York Stock Exchange or the Nasdaq are highly liquid because there are many buyers and sellers. Your orders most likely execute within seconds if you place a market order.
There is almost always a buyer because there are a lot of market participants and the market uses technology to facilitate transactions.
When there are no buyers
It is rare, but especially during times of crisis, there may not be any buyers. That is when you'll see stock prices fall extremely quickly because existing sellers are willing to sell at any price.
In response, stock exchanges use “circuit breakers” to halt trading temporarily. It's a bit like pumping the brakes on a car—you want to slow down the fall so panic selling doesn't take over. These breakers may freeze an individual stock or the entire exchange when an intra-day move exceeds certain percentages. There are three “breakers” corresponding to longer and longer halts in trading.
Trading might resume in as little as fifteen minutes for the first breaker or as long as the next trading day if all three breakers are hit. Some of the most recent circuit breakers trips were triggered in March 2020 because of the selling early during the pandemic.
Why others buy stock when you sell
Each of us has different investing goals and investment plans. You may be saving for retirement while someone else is day trading stocks. Or you're an institutional investor managing a billion-dollar pension. Different goals mean different motivations and actions.
If you are selling, why might someone else be buying?
They have regularly scheduled investments
There are investors who have regularly scheduled investments, such as a retirement account contribution each paycheck. This approach is an investment strategy known as dollar cost averaging.
Every month, these investors will buy shares at the market price without a specific reason other than it's payday. I do this every month when I contribute to my retirement accounts—I buy shares of an index fund regardless of what I feel about the future of the market. I buy based on the day of the month and nothing else.
They are buying the dip
There are a lot of reasons why a stock price might drop, such as a surprising earnings miss or a broad market correction, but some investors believe in a strategy known as “buying the dip.” If you feel that the market over corrected, you might want to be buying shares.
Investors with a long-term investing horizon might invest extra cash when shares drop 10%. “Buying the dip” is like buying extra groceries during a buy one get one free sale.
They have limit buy orders
One investing website maintains an annual Buy List of companies with an updated "Buy Below" prices. It adjusts those prices but believes that a company is worth accumulating if their prices fall below this "Buy Below" price.
Investors who follow this practice may set long term good-til-canceled limit buy orders that trigger when there are big dips. They set these because they know they want the stock at that price but don't want to check prices all the time. If there's a sudden drop, they are willing buyers.
They are covering short sales
If you were selling your shares after a drop in price, you might be selling it to someone who believed a drop was coming.
They are known as short sellers. If you think a stock's price is going to fall, how would you take advantage of it? One strategy is to borrow shares of stock from someone else, sell them on the market today, and then buy them back when the price has fallen.
If the stock price does sell, and you go to sell your shares, the buyer may only be buying them to give back the shares they borrowed. They may not believe the company is worth owning at all!
They are swing traders
Many long-term investors use fundamental analysis like analyzing balance sheets and earnings call transcripts to buy or sell positions. You might be selling because you think the future of the company looks bleak.
Other investors believe that they can use technical analysis to identify opportunities. They use these technical indicators to day trade stocks based on relatively small movements in the price. One common indicator is the idea that a stock can be "oversold" or "overbought" and based on the Relative Strength Index.
In some cases, investors trade the headlines in hopes of making a quick profit. One example is when a CEO unexpectedly dies or resigns. Another example is when an analyst lowers their rating for a company from "buy" to either "hold" or "sell."
They aren't buying because they believe in the company, they are buying because they are trying to take advantage of short-term volatility.
They are rebalancing
There many times during the day, week and month when you will experience atypical market behavior because various groups are required to perform certain actions. These times are often very unpredictable because of quirks in the schedule.
For example, one of the most volatile times to buy or sell stock is during the first and last 15 minutes of a trading session. These windows are the time when many institutional fund managers—including index funds—rebalance their portfolios.
An individual buyer may be personally rebalancing their portfolios. This is often done by selling assets that have seen gains and buying those that have lost value.
It's a witching!
Have you heard of a "witching" on Wall Street?
Stock options, a contract that confers the right to buy or sell stocks at a certain price, expire on Fridays. You have stock options, stock futures, stock index options, and stock index futures. A triple witching is when three of them expire on the same Friday. A quadruple witching, which only happens four times a year, is when all four expire on the same Friday.
During these days, there will typically be much higher trading volume as profitable contracts are executed. Someone might be buying your shares not because they love the company but because they are involved in exercising an option.
Maybe they are a greater fool!
Another reason there is almost always someone willing to buy is the "greater fool theory." This theory states that someone is willing to buy an already expensive asset thinking it the price will go higher and they can sell for a profit.
Every few years, we hear about how a financial bubble is bursting for a particular asset class. Before the bubble bursts, there is a sharp increase in asset prices. Some of those last investors are buying because they experience "FOMO"—the fear of missing out.
Technology stocks were the bubble in the 2000 "dot-com bubble." Some companies like Microsoft and Apple have more than recovered from this crash. But many companies went out of business or have yet to regain their all-time highs from 20 years ago.
Focus on your plan
Now that you understand some of the reasons why others are buying when you are selling—it's best to focus on your plan and not what others are doing. If you are going to sell a stock, it's for your reasons based on your plan.
You might be selling because you need the funds for another project. You might need to rebalance or your belief in the prospects of that company have changed. Whatever the reason, look to, and update if necessary, your financial plan so you can achieve your long-term goals.
If our markets are functioning and healthy, they offer one of the best opportunities to build wealth and we should take advantage of it.