Stock Market for Beginners

I’m sure that you’ve heard of the Newton’s third law, “for every action there’s an equal and opposite reaction.” Well, this law certainly rings true for the stock market. You may not have realized, but every single time you make a trade - whether to buy or sell - there’s another person (or trading system) on the other side of the trade.

What are the implications? Let’s say (theoretically speaking) that you believe that Apple’s iPhone will have a large impact on its bottom line in the next quarter. You believe that Apple’s stock price is undervalued and think it will go up soon, so you purchase 100 shares of Apple. Well, if you’re buying 100 shares of Apple, then that means there’s someone (let’s call him Mr. Pessimist) on the other end of your trade selling 100 shares of Apple. Now I know you’re asking, so what? This is crucial because Mr. Pessimist must believe (for the most part) that Apple is overvalued and will go down, otherwise he wouldn’t have sold the stock!

Here are of the most common reasons Mr. Pessimist decided to sell you his 100 shares of Apple:

• Profit taking - Mr. Pessimist may have just made a large profit off of Apple and does not want to risk losing it.
• Limit losses - Mr. Pessimist may have set a stop loss order to minimize the amount of loss he was willing to take on the stock.
• Short selling - Mr. Pessimist may be so pessimistic about the stock that he is betting the stock will fall. In this case, he is borrowing 100 shares of Apple from the broker and selling it to you with the intent of buying back the shares once the stock has fallen in value.

Final Thoughts

It is crucial every time you make a trade that you think about Mr. Pessimist’s (or Mr. Optimist’s) rationale for taking the other side of the trade. Clearly, he believes that the stock will perform in a manner opposite to your own beliefs. If you can truly understand his motivations and find that they are unfounded, then you will be well on your way to making a lot of money.

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