“The Investment Club” column: David Morris, Church Street Advisors: How the market works
By David Morris, Church Street Advisors
news@williamsonherald.com
It was Edward Lefevre, one of the great stock market operators of the ’20s, who said that “The market is going to do what it has to do to frustrate the majority of the players.”
That is as true today as it was in the ’20s. Anyone who witnessed the meltdown of the last few quarters can attest to the fact that a vast majority of long-term investors were very frustrated.
Step two in the process of being a smarter, better investor is an understanding of how markets work. Someone once asked me, “Who sets the prices every day on the market?” I replied with a dissertation on the auction process and specialist system, and I noticed pretty quickly that their eyes were glazing over.
A simpler illustration might be more appropriate.
Every day in the stock market, we have an election. The settlement price at the end of the day is set by the voters who showed up at the polls that day. Some days can be rainy, and voter turnout is low. On other days, everyone shows up to vote. The price at the end of the day is the result of the voting for that day, and that is the price we see in our newspaper and on our financial statements the following day.
Suppose that you and I and everyone we know shows up to vote. Most of us are probably going to be voting similarly, because we all have similar views. We listen to the pundits and are influenced by the garbage that is fed to us through the popular media.
We tend to all get brave at the same time, and we tend to be depressed at the same time. We all vote the same way – we are the clear “majority.”
Then imagine this. Every time we go to the ballot box to cast our vote, there is someone standing at the box who votes right after us. So I vote and he votes, and you vote and he votes again. He gets to vote as much and as often as he wants to – kind of like a Chicago election.
We are all voting, but our votes don’t matter – that magical person gets to vote against us as much as they want.
That’s how the market works. The mystery voter standing by the ballot box is the institutional investor. He is either a big hedge fund or the manager of a large mutual fund. We can all have an opinion, and we can all act on it.
But if Mr. Institutional Investor has a different opinion, we are all in trouble. We are in trouble because we have thousands and thousands of dollars to buy, but he has millions and millions of dollars to sell. He is always going to win. So now the question becomes, “Are you going to vote with him or vote against him?”
Well, the answer to the question originally posed – “Who sets the prices every day on the market?” – is the one with the most money, and that is the institutional investor. You can either get on the same side as them and win, or fight them and lose.
The next obvious question becomes, “How do you know what the institutional investor is doing?”
By asking that question, you have made a quantum leap in your understanding of the market. The reality is that what you or your brother-in-law or the guy on TV knows or thinks is totally irrelevant.
You can now start down the path of trying to find out what the guy in Boston thinks – the one who is hitting the button to buy or sell millions of shares. After all, his opinion is the only one that matters, and you want to be on his side.
These guys that are moving the gazillions around in the market are a secretive bunch. They are not going to sell their ideas to you for a commission, and they are not going to publicize what they are doing – especially while they’re processing the transaction.
But they do have one highly significant handicap that you don’t have – they are big. Really, really big. And really, really big investors leave really, really big tracks.
When they decide to buy or sell something, it sometimes takes them days, weeks or even months. They don’t follow the trends… they make the trends. You can pull up the history of any security, and most of the time, you can see exactly what they are doing if you will just look.
Yogi Berra once said that “you can see a lot by just looking.” I am continually amazed by how many people decide to buy or sell something without even a cursory look at the price history of the stock.
Doctors look at charts, engineers look at charts, the Federal Reserve looks at charts, and you should look at charts. They don’t represent irrelevant opinions – they represent what real people are doing with real money.
Don’t get carried away with the technical analysis jargon. Remember – simpler is better, simplest is best.
Draw a line through the price action for the last few months. If that line is pointing down, don’t buy it. The simplest analysis can save you a world of hurt. That line pointing down is not Aunt Sally selling! That is a major institutional investor dumping large volumes of shares. He is big, he is smart, and he probably has a lot more stock to sell before he is through.
Maybe you can watch and look for signs that he is finished. But chances are, you will find out much later exactly why Mr. Big Bucks was so eager to sell.
David Morris, an investment advisor and principal at Church Street Advisors in downtown Franklin, leads The Investors Club, held twice a month at Stoveworks in The Factory. For more information, email him at dmorris@churchstreetadvisors
Posted on: 9/10/2009
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