When I speak of investing in stocks I often mention investing in a business in the same breath. I do this because I see investing in a stock as being synonymous with investing in a business. It is true that when you buy stock you buy ownership in a business and thus become invested in the specific business. Though the previous sentence holds true, it does not mean that investing in stock and owning a business are the same thing.
In the last few weeks we’ve seen dramatic swings to the positive and negative in the market. The market’s manic behavior is a perfect example to show the principle reason why investing in stock is not the same as investing in a business.
When you take ownership of stock your commitment to that business can be canceled as quickly as a millisecond. No actual business owner has this ability. Operations, employees, contacts and other affiliated business components cannot be done away with in the blink of an eye. Therefore, the market, while based on businesses throughout the economy, is likely to be only a partial reflection of the true economy.
The market’s structural makeup – the way in which buyers and sellers interact – is the reason that we cannot fully rely on the market to be ultimate truth when it comes to the well being of an economy. When a stock owner has the ability to enter or leave a position at a moment it is easy for a wild range of emotions to drive such behavior. Since an actual business owner cannot rid him/herself of ownership at a moment’s notice, the world of actual business ownership and stock ownership are not congruent.
One of the great things of the market is the fact that an investor can quickly establish or leave an investment position. While this is very beneficial, it comes at a cost. With entry and exit being such an easy chore, the spectrum of human emotions can easily overtake the market whether they make sense or not. Thus, market corrections can quickly become market panics and bubbles can be built within a few months as euphoria overtakes investors.
The market is an arena where people interact in buying and selling. The buying and selling can be based on careful reflection or knee-jerk reaction. Since we can act at a moment’s notice, it must be understood that our passing emotions can more easily influence us than we’d like to admit and drive us to acting without any real sound basis for buying or selling a stock.
Part II to follow – I’ll look at a few additional areas that can make the market act manic.