I'm clearly new to investing, but I have an odd question..
So I understand that if we all buy shares of a company that the value (price per share) goes up.. we all sell and the share value goes down.
So what if Warren Buffett took his entire fortune and invested in a penny stock. Say VICL. Shares go from $1.11 to some much higher number.. right?
Well what if he sells right away? He ends up with huge profits (bought at 1.11, sold at new higher number) and walks away with a monster profit..? I have to be missing something here.. where would that money actually come from? If he buys and then immediately sells he should walk away with the same amount of money (minus fees) that he started with.
What am I missing?
Thanks,
Ryan
You're describing a modification of "pump & dump" where you buy the shares, use social media to get other new buyers excited, and then sell to them as they frantically bid up the share price. Jonathan Lebed did this as a 15-year-old:
http://en.wikipedia.org/wiki/Jonathan_Lebed.
If Buffett (or anyone else) was to sell as soon as they buy, then they'd be in danger of putting more shares up for sale than anyone wants to buy. That would cause the price to drop, and they'd actually lose money. High-frequency trading computer programs try to do this with highly-liquid stocks, but balancing buyers & sellers to assure a profit is not easy to do. You're also paying a huge chunk of your profits in taxes, so you end up taking very big risks for very cheap wages.
Day traders (or swing traders, or momentum traders) buy because they see a bunch of other buyers flocking to the stock, and they hope to buy & sell ahead of the herd. Again, to torture another stock market cliché, they risk getting trampled in the stampede if the momentum changes while they're holding the shares. I'm only aware of one trader who managed to trade his way to early retirement, and he had a miserable life before he hit his winning streak: Gary Smith of "How I Trade For A Living". He essentially stayed glued to CNBC for much of the day, trading mutual funds on momentum.
The reason people buy like Buffett is because he's a notoriously cheap value investor. (Don't be fooled by the kindly ol' guy act. Read his biography "The Snowball.") He can easily cause a buying stampede if people know what he's doing, so he has a guy whose sole job is to stealthily buy/sell shares of the stocks that Buffett wants to buy/sell... every day. It can take weeks or months to build up or liquidate a position without causing the price to surge (either way) on his buying/selling demand. It takes him so long to do this that he regularly asks the SEC to let him keep his buying/selling in certain stocks a secret for up to a year. Sometimes the SEC agrees, other times they don't.
It's at the point now where Buffett finds it cheaper to deal directly with the company-- either buying the whole thing or buying preferred shares directly from the company (outside of the stock market). Sure, he could scoop up a few pennies per share with a short-term trade, but the reason he's buying in the first place is because he thinks he's buying dollar bills for 75 cents. Studies have corroborated his judgment: if you buy (or sell) Buffett's updated holdings on the day after he makes them public, you'll make a profit. You won't necessarily beat the market, but you won't lose money... until everyone starts following in Buffett's footsteps. When enough people pile into this sort of tactic then its advantage disappears.
Two questions from this conversation
1) If there is a buy and sell price that has to be agreed on, who set those moving prices?
2) Does every company in the stock market have a specific number of shares that never grows unless there is a split? Because in order to purchase stock you would actually have to wait for someone to sell a stock that you can then purchase one, which does not seem to be the case.
Sorry if this is trivial.
1. Market makers match up the bidders (buyers) & askers (sellers) at a price that keeps 'em coming back for more. This is largely automated. Individual traders can set limit prices at which they won't sell below or buy above, so there's some control over what price you're willing to pay/get.
Market makers are also supposed to stabilize volatile markets by buying excess shares when everyone else is selling. They do this with either their own money or by borrowing money on margin. There's an apocryphal story of market makers coming to work after Black Monday (
http://en.wikipedia.org/wiki/Black_Monday_(1987)) with the titles to their homes in order to deposit enough collateral for the money that they'd borrowed on margin.
2. A company will authorize a total number of shares. They'll hold back a certain percentage of their authorized total to give to execs or employees, sometimes referred to as the "options pool" or "restricted shares". Some shareholders may never sell (or might have had to agree to hold for a certain period), so the "float" of available shares is always a smaller number than the authorized number of shares.
Publicly-traded companies usually replenish their pool by buying back their shares on the open market. Smarter companies buy their shares back when they're undervalued (or in order to artificially
bluff "support" the share price). There's a raging perpetual debate over what a company should do with its excess cash: issue a dividend (give up the cash?!?) or buy back its stock (to make the remaining shares more valuable). Companies generally have a terrible track record on buying back their own stock by overpaying for it when it's fairly valued and not buying it back when it's "on sale". Other companies have buyback goals or policies where they claim that they'll try to buy a certain number of shares per year no matter what the price may be.
For example, Berkshire Hathaway has publicly stated that they'll start buying back their own shares on the open market when the price reaches 110% of book value. In today's numbers, Berkshire Hathaway is selling for about $115/share but has a book value of about $85/share. Even Berkshire has
violated made an exception to their rule, once paying almost 120% of book value to buy a giant block of shares from the estate of a large shareholder.
But otherwise, yeah, you have to either pay what a shareholder asks or negotiate the price. Most buyers pay whatever the market maker's price may be, and a few buyers set a limit on what they're willing to pay.
Most publicly-traded stocks are traded so heavily that we retail investors never notice any of this. Market makers only become critical when the markets go nuts, or when buyers/sellers are moving huge blocks of shares, or when a company's shares aren't traded very often.