Supply and Demand, All You Need to Know

The old adage “Fool me once shame on you, Fool me twice shame on me!” might have far more consequences than most care to ponder. In financial markets or for that fact, any vehicle that has the aura of “You can get rich” attached to it, does not adhere to the same principles or rules that one assumes to be in play. Everyone believes that the law of supply and demand works for all markets the same way. Guess what? They’re wrong. Let me show you why.

Basic assumption: Create a widget, as more consumers buy pricing goes lower because of savings or efficiencies in manufacturing, distribution, and so on. More brands come in to compete based solely on the “I can work on smaller margins than you can.” mentality, which drives prices down even further. A great example is the flat screen TV revolution. Remember when they were $3000.00 or you go home with nothing? Supply and demand model at work as most understand it. However, let’s use something else that flies in the face of what you think to be true all the time. Financial products.

Here’s where everything gets turned upside down. I’ll use the stock market for this example. As a stock comes to market there are the early adopters, the first ones in. They get in with the assumption that their purchase is at the bottom of the price curve, or the discounted end, and the supply is sharply limited. As a demand from others begins to take place in their wanting to purchase, supply begins to get added to the market. (adding shares to be sold to the public) Guess what? Prices don’t go down, they go UP! The more they produce, the higher they go. Why? Because it’s not a widget based formula, it’s an emotional based formula. And the two are not the same. It’s counter intuitive for most to grab hold of which is why it can be so financially devastating to the unsuspecting investor. The higher it goes in price, the more people want in on the deal. Double, triple, quadruple the offering and it seems you can’t make enough supply to feed the emotional buy in…Till it hits the wall!

The wall I refer to is that point when everyone who could buy, did buy. And here is where the wall meets the fan. And it’s usually not pretty. If you now want to cash in those profits you have to sell, but now you’re surrounded by hordes of bag holders just like yourself looking to get someone to take their bag first before you have a chance to sell yours. Now the rule of supply and (No) demand comes into play. And because it’s all emotionally based, panic starts to creep in feeding upon itself with a rush not to be the last person holding a bag. The final result usually ends with not only many people holding bags, but they now have to pay some refuse company to take it away. Remember Enron? There were people still trying to sell their bags after the company declared itself out of business. That falls into the “Greater Fool Theory” and that’s for another column.

So when trying to grasp different theoretical models just keep this in mind. The difference between the two models is this. If your wrong or early in buying a TV you still may have the TV to watch, but if you’re wrong or early in financial products, you may not have any money to pay the cable bill. And the models worth watching are on cable.

At least that’s what I hear others say.

Mark

© 2011 Mark St.Cyr  All Rights Reserved