The Markets

What is the stock market — why does it exist? Why does it all seem so complicated? Why are all those men shouting at each other in the trading pit? Look at all those idiot public schoolboys barking into telephones...how boring!

If the paragraph above matches your feelings about the stock market, we quite understand — we used to feel the same way — the purpose therefore of this essay is to try and convince you, why you — personally — should be very interested in the stock market. Whether you like it or not, whether you think it affects you or not, the market lies at the very centre of our society — it is the hub, where the flow and distribution of goods, money and services is regulated and while you may think, quite rightly, that it is work, and money, and taxes that make our modern lives possible, at the very centre of all of this lies the market as the facilitating medium.

Why the Markets Matter to You

Not convinced? Let's go through a few examples:

Got a job? Chances are you work for a large company, and it will be quoted on the stock market. If its share price goes down, the shareholders will be very unhappy, and your management may have to change the way they do things like, for example, reducing labour costs — by firing you. If they fire you, they may even shut down the entire plant; the local firms who supply the plant will lose revenue and they might go under as well. Even the hamburger van which is usually parked outside the factory gates could find itself up for sale. Decisions made in far-away, sometimes foreign board rooms affect you and your family, personally. Sluggardly share performance can have nasty consequences for a great many people as the knock-on effects will cascade ever outwards.

Got a house? Chances are you are paying off a large loan on it, commonly known as a mortgage. Naturally, the interest rate is of concern to you — for example, if it rose sharply you might find yourself going under, and if it fell sharply, you might be tempted to remortgage and then move to a larger property. Interest rates are set by the Bank of England, usually in response to what the stock market is doing; if the economy is 'overheating' interest rates will rise, and if the economy is 'slowing,' interest rates will be cut; the idea behind all of this is that interest rates define whether it is cheap or expensive to borrow money — cheap money, i.e., low interest rates are an incentive for people to spend, and vice versa.

Got a pension? The value of almost all pension funds is strongly dependent on market conditions; what the fund manager does is to take your pension payments and buy stocks and shares, hoping that their value will grow — for this they earn fantastic wages. So, if you do not wish to spend your twilight years in abject poverty, you'd better hope that the stock market hits a powerful 'bull run' during your working years.

Got a savings account? The interest your money accrues is set in relation to the Bank of England base rate, mentioned previously.

Do you eat food? The price of the food you buy is set by market forces; commodities are traded on the markets — and what you pay in the shops for a product depends on the costs of the raw materials needed to make it.

Do you drive a car? Cars run on petrol, which comes from oil. Oil prices are traded daily on the markets.

Please, no more examples, I think I get the message!

Apologies for over-egging the custard here, but I just want to make the point clearly — there is nothing that doesn't depend on some underlying market process, unless of course you have chosen to live in a cave, eat grass, walk everywhere and spend your days lazily dreaming...to me that doesn't sound too bad a life, as long as the weather was not too inclement, but alas, like most of modern man, I quite like central heating, hot baths, good dental care, fresh fruit at any time of year, the Sony PlayStation and BMW cars.

OK, all of this is going on around me, but surely there is nothing that I as an individual can effect, we are passive observers surely? What can I do?

Quite a lot as it happens; markets are very reactive systems — if you as an individual make a decision to act in a certain way, it will on its own have little affect, but if a million like-minded individuals do the same thing — that will have a major effect. So far, individuals have had tremendous influence — indirect influence — on the markets, mainly by choosing where they decide to spend their money — but I believe the time is ripe for private individuals to take a more active role in their dealings with the markets, by investing and trading on their own behalf and although there are many obstacles to doing this, little by little they are falling.

A small point before we continue — I have talked of the market and the market system, when what I really mean is capitalism — that is the proper word for it after all, but capitalism, like socialism is a politically charged word and I don't want to discuss political arguments about the market; good versus evil, right and wrong, or theoretical utopian societies that function without the market — these are of no interest to me (at least since I left my student days behind), and should not be to you either.

This is the world in which we live, a world we did not choose to live in, but it is the only one we have, so I shall examine this rather than any other world — but if you did find Planet Utopia, I'd be very interested!

History of the World, part 1

Let us start at the beginning, the very beginning...

Early man was a self-sufficient hunter-gatherer, existing on a variety of fruits, roots and meat; a very good balanced diet, when it was available — but much of the time it wasn't, and when combined with the effects of predation from other animals, his existence was a rather precarious one overall. There was also the small matter of the Ice Age to deal with.

Growing food in an organized manner thus seemed to have a lot of advantages; a regular supply for one thing, and more of it. Families could become larger, more work could be done. Once small settlements evolved and basic agriculture had been developed, man was well on his way to civilization.

Because people were more static, land became valuable, and the idea of property emerged. Aggregations of people meant that peoples activities could become specialized, people could concentrate on what they were good at, and so new technologies could develop — weaving, metalwork and so on. This also meant that people had to trade with each other for all the things they needed, and for trade you need markets — recognised places for doing so. Large settlements grew up around these places — wealth and power accumulated, and there emerged rich and poor.

Early trade was done via the barter system, but this was unwieldy — at some point, someone thought of the idea of money — a universally recognized means of exchange which was much easier to deal with than goods themselves; most early societies valued precious metals and so most early coin was either gold, silver or copper.

Scottish Insights

Skipping forward several thousand years through the rise and fall of many civilizations, countless wars, many religions, many 'systems of rules for living by,' we get to the first major academic study of the market system — the 'Wealth of Nations' by Adam Smith. This two-volume work sets the theoretical foundations of capitalism; the fascinating and central message is that to work best — and let us emphasise this:

Markets should be left alone by governments, and that the best overall social outcome arises from the self-interested actions of individuals through the ('invisible hand') action of the market...

This leads to the phrase 'free market' — you've probably heard that used a lot.

These ideas were obviously political dynamite at the time and have been used ever since by right-wing politicians and industrialists to justify any number of repulsive actions as being natural outcomes; to this way of thinking, good and selfless actions are pointless, charity is simply a waste of time, and support for the poor doesn't work — all we need is selfishness plus the market ('greed is good'). Rich people especially love the idea that the best outcome for society will be achieved by them doing precisely whatever they want to do, whenever they want to do it.

German Counterpoint

The next major student of the capitalist system was a middle-class London-based German exile called Karl Marx. Living in near penury, supported by backhanders from his drinking buddy Engels — he spent his days at the British Library, his life's work a grand 'trying to make sense of it all' — to understand the forces that drive history itself. The final outcome of his exertions was the massive doorstop, 'Das Kapital.'

The programme of Marx was a simple one — by laying bare the realities of how the market system actually worked, he would provide the intellectual weaponry required to underpin the many fragmented and hopelessly utopian socialist programmes of that era — most of which were dominated by grand, egotistical orators who had little genuine intellectual weight. For the crime of attempting to provide the masses with such intellectual gunpowder, Marx was roundly demonised within his lifetime and ever since, becoming for many a quite ridiculous bogeyman.

But Marx had many insights — he speaks of globalisation 150 years before it became a fashionable topic, he understood the part that technology would play in the development of the market system, and he foresaw the future catastrophes of European wars; not bad for such a denigrated and despised man, whose philosophy has been 'refuted.'

What Marx correctly recognised in the markets was their instability — that there would be cycles of boom and bust and that the whole system quite naturally tries to shake itself apart; he further believed that a general collapse of the markets would lead to a social upheaval so severe that revolution would occur, heralding a transition to a new, better type of society.

So far he has been wrong; while there have been many serious financial crashes, the markets have always recovered, but in order to do so — and quite in opposition to the idea of a free market — we have had generations of politicians, economists and central bankers spending their entire time attempting to stabilise and control the markets.

The situation today

So much for the past — isn't history 'mostly bunk' anyway? What of today's market system?

Today's markets operate largely electronically — most trades are carried out via computer terminals allowing instant execution, though some are still done by open call in trading pits. The players in this game are:

Traders

Take instructions to buy and sell stocks either on the trading floor, or from their terminals.

Exchanges

Provide the necessary, mostly electronic, infrastructure to allow trading to take place. There are many of these, often specialising in one geographical region or type of security; examples would be the LSE (home of the FTSE 100), the NYSE, the NASDAQ, and the LIFFE (UK-based options and futures market). In recent times there have been talks of mergers between the exchanges — expect this to happen a lot more in the future.

Brokers

Sell stocks. Take orders from investors, instruct traders to carry out the trades.

Analysts

Research company financials, and make recommendations.

Investment banks

Employ analysts; trade on their own behalf and for clients; do deal-making for large companies.

Quoted companies

Sell their stocks via their brokers.

Governments and central banks

Try to stabilise the markets, while attempting to provide the economy with steady growth.

Rich individuals

Employ analysts and instruct brokers to make large trades on their behalf.

Small investors

Buy small amounts of stock. Of limited interest to the brokers, but potentially a huge market, hence the growth in discount and online brokerage firms during the last boom. People like us.

Pension funds

Major traders on the markets.

Institutional investors

Companies who invest in other companies; pension funds and insurers are two examples.

So much for the 'central importance of the market in our socio-economic fabric' (and I do apologise if my history lesson has bored you) — the essential fascination of the stock market is that you can make lots of money on it. Lots of money. Theoretically unlimited amounts of money, in fact; much better than any bank account, and there is nothing more satisfying to the ordinary hard-working person than the prospect of unearned wealth. Of course, you can easily lose all your money, too, and it takes a brave man to become a serious investor; the first time you take a look at the chart of a share price should give you a damn good fright — share prices appear to wander about rather randomly and with great changes in their value; there are other obstacles as well for the smaller investor — trading costs, for one example, and a lack of information — when things happen, he will normally be the last to know.

It should be pointed out that the other market players like the small investor — they like him a lot — they see him as being the 'mug punter' of the market game; gullible, getting in and out too slowly, paying exorbitant trading costs, acting on out-of-date tips they read in newspapers or on dubious Web sites, and really, being a person who it is rather easy to take money from. Small investors are thus encouraged, e.g., to use long term buy-and-hold strategies, even when share values are plummeting, and the basic danger of the market is used even further to encourage small investors into using managed funds, ISAs and other 'safer' investments; but this is simply giving your money to someone else to gamble with on your behalf. Don't do it — it's not a good idea.

Getting involved, directly, personally

It is time for the small investor to become more active and take more responsibility for his financial wellbeing — to get himself empowered, as the Americans would put it.

Don't do what the government want you to do — buy an ISA and shut up
Don't do what the brokers want you to do — buy any old stock they want to shift
Don't do what the big companies want you to do — buy our stock and hold it forever

Time to trade actively, on your own behalf. But to do this you need the right tools.

StockWave™ gives you — the small investor — the scientific data processing tools you need.

The markets

What is a share or stock?

Bonds, gilts and commodities

Derivatives, futures and options

How to trade

How to analyze chart data

Trading strategies