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Friday, October 7, 2016

Two Common Misconceptions about the Stock Market

Listening to experts and analysts on business TV channels (in fact, watching any TV channel) is mostly a waste of time, but can be a source of entertainment also.

Leave aside the odd attempts at levity after close of trading on a given day. It is what they say during trading hours that can be quite funny.

One example is: "There is a lot of money waiting on the sidelines to enter the stock market." 

So, where is this money? Stashed under a mattress? Temporarily parked in a liquid fund/savings account? To be borrowed from a rich uncle? It doesn't really matter.

What happens when this money does enter the stock market? It is exchanged for shares of one or more companies. (That is why the market is called a Stock Exchange.)

What happens to the money thereafter? It changes hands. From the buyers of the stocks to the sellers. Now the buyers are 'in the market' and the sellers are 'sitting on the sidelines'.

In other words, the 'money waiting on the sidelines to enter the market' remains on the sidelines. 

(In the primary market, i.e. during an IPO or FPO or rights issue, 'money waiting on the sidelines to enter' goes to the share issuing company and no longer remains on the sidelines.)

Another popular misconception is: "The stock market is a zero-sum game." 

What is a 'zero-sum game'? A game or transaction in which there are one or more winners and one or more losers - with the gains of the winners exactly equalling the losses of the losers.

Let us say two friends buy a stock for Rs 80. They sell it for a gain of Rs 20 a couple of months later. That means, the buyers pay Rs 100 for the same stock. What have the buyers lost? May be an opportunity to buy earlier at Rs 80 - but no real loss.

In fact, if they manage to sell the same stock for Rs 110, they will also gain. They will lose only if they sell the stock at a price below Rs 100. If they sell at Rs 90, their losses will not equal the gain of Rs 20 made by the original sellers.

The reverse also holds true. If some one buys a stock at Rs 100 and later sells it for Rs 80, he loses Rs 20, but the buyer doesn't gain anything. (By the way, any ideas where the lost Rs 20 goes?)

Not really a 'zero-sum game', is it? 

Moral of the story? Take everything experts say on business TV channels with a pinch of salt. (That particularly includes their buy/sell recommendations.)

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