Most people who become interested in financial markets just want to know one thing — how do I make money? Before they know it they resemble a dazed pre-schooler in a post grad finance class. Before you look at anything to do with strategy, asset allocation or derivative of choice, its important to stop and consider the essence of what a market actually is.
Now, this may seem obvious to you — if so great feel free to skip the rest of the article, but when I became interested in finance it wasn’t obvious to me.
I was that person that was transfixed on trying to learn how to enter and exit trades, rather than figuring out what game I’d just joined. Instead of getting a solid foundation on the basics of markets, I was window shopping the winnings of pro traders. This is a mistake you don’t need to make.
A market’s a market
The concept of markets is really basic, and they are the same no matter what the product being traded is. The purpose of the fish market at your local port is no different to that of the gold souk in Dubai, Bitcoin futures or the bond market. There are things at that market people want to either buy, sell or exchange other goods for.
Of course, these markets have their own idiosyncrasies, but they are all the same in that they are all — markets.
A market, is just a place where a load of people get together for the purchase or exchange of goods and commodities. They are the very underpinning of trade, and its only relatively recently that we have started to think of markets more exclusively as digital entities rather than the physical things they were for centuries.
We should probably cite a definition
Let’s look at what Wikipedia has to say:
“A market is one of the many varieties of systems, institutions, procedures, social relations and infrastructures whereby parties engage in exchange. While parties may exchange goods and services by barter, most markets rely on sellers offering their goods or services in exchange for money from buyers.”
Classic academia there — complicating the hell out of a simple idea, and its often this complication that people get really wooly about markets really quickly.
The point I’m making is that when you are sitting on a screen trying to figure out what you want to do with regard to a particular investment, trade or pension portfolio — try not to loose site of this basic idea.
Why, you ask?
Because markets are just the meeting point of people, these participants are just fallable humans and their decisions are made pretty much exclusively on their fallable emotions.
These emotions drive decisions, which in turn drives prices and thus moves markets. Moves in markets cause the financial media to spread hyperbole, which causes the less informed investor to listen to emotions, and often times cause everyday investors to make bad decisions.
The Market Economy
Ok cool, so that’s markets — what about the market economy?
Let’s try Google this time:
“An economic system in which production and prices are determined by unrestricted competition between privately owned businesses.”
That one is a little easier to understand. Basically a market economy is one where the overall interactions of buyers, sellers, consumers and businesses (basically just a collection of markets) dictate the price of goods and services due to the fluctuation of supply and demand. This in turn impacts the production of those goods and services.
Market economies are interesting things, and I’ve become fascinated by them — more to come in the future on this I’m sure.
For now though, the important thing to remember is that markets form the foundation of a market economy, and as we’ve discussed a market is just the method through which individuals are freely able to trade with each other. Crucially, it is the requirements (read emotions) of those individuals that affect how they conduct that trade.
How is this useful when investing?
When considering your own investments, whether they are long term investments in a pension fund or a savings account, or short term speculative trading, you need to really own the decisions you make.
I’ve learned its important not to rely on the others understanding what is happening, you need to understand it too. This way you be much better placed when making investment decisions.
In order to make those decisions you need to keep hold of the basic idea of what is driving the price darting around on your screen, you need to disconnect from financial instruments being just a chart, and remember that deep down somewhere, the basic idea of a market, the coming together of individuals looking to trade, and the emotions they bring with them is driving what your eyes are seeing on the screen.
By remembering this, I’ve found it much easier to both relate to how others might be feeling, and therefore how they may trade, and also guard against falling into the trap of thinking there is a “right” decision to be made at any given time based purely on knowledge of any particular trading strategy — markets are not scripts.
Trading and investing may feel digital these days, but by remembering the basics of what a market is, we can keep it firmly rooted in the real world, and hopefully not “lose our shirt while others are losing theirs”. Understand this early, and it’ll pay dividends in the future.