This section covers the inner workings and inner principles that define and drive the markets. Despite being more difficult and apparently less practical than the basics, it’s very important to learn these concepts.
The generally accepted definitions for what a market is, go along the lines of:
A market is one of 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 (including labor) in exchange for money from buyers. It can be said that a market is the process by which the prices of goods and services are established.
In mainstream economics, the concept of a market is any structure that allows buyers and sellers to exchange any type of goods, services and information. The exchange of goods or services for money is a transaction. Market participants consist of all the buyers and sellers of a good who influence its price. This influence is a major study of economics and has given rise to several theories and models concerning the basic market forces of supply and demand. There are two roles in markets, buyers and sellers. The market facilitates trade and enables the distribution and allocation of resources in a society. Markets allow any tradable item to be evaluated and priced.
Now, those definitions are excellent but they don’t exactly help to teach a trader how to make a profit or even why. This course does not even try to be “formally and politically correct”, those who are after textbook perfection are never going to make it in the markets.
As previously described in The Foundations Of Trading,
- Markets are a place where supply meets demand and feelings of fear and greed are exchanged.
- Markets are a self optimizing, self healing, zero sum game where buyers and sellers exchange relations and, optionally, assets.
- Markets are also self-similar: like a fractal, every market price feature may be decomposed into identical smaller features going to smaller time frames and likewise markets features compose larger timeframes market features.
These short sentences have very deep meanings and consequences.
- Zero sum game. This means that for each transaction, even the fairest of all, there is a winner and a loser. The winner managed to take or give away his assets at a better (not necessarily optimal) rate than the counter party. In example, if a seller traded and gave his stock to a buyer while price was about to begin declining, that seller “won”, even if the buyer is perfectly happy with the deal.
An additional but fundamental detail: markets are a zero sum game but seen from the inside they are not. There is always a little or not-so-little fee to pay to the broker, to the exchange, to the state (in example: transaction taxes). Therefore at the end of each transaction, a portion of the currency used is leaving the market to enter some third entity’s wallets. Along with the so called “bid – ask spread” this is a major factor affecting day by day trading.
- A market involves two or more parties or counterparts, often simply called “buyer and seller“. Today’s modern markets often involve additional parties: a broker acting as middle man, a regulated exchange, liquidity providers helping keeping markets “smooth” and more. Since this course is for practical trading, the focus will be mostly aimed to buyers and sellers. Buyers and sellers are the collective of markets participants. They both participate into and make the market, that is their interactions and deals relationships form price. Price is the value given to the traded assets at any given time. Price has no strict or compulsory tie with mechanic aspects like supply and demand.
Practical trading involves getting away from some theoretical concepts, like “perfect information”, “perfect competition”, “brownian motion price discovery” and so on. Some additional material for thought may be found here. Practical traders know that there’s nothing perfect, all has a cost and markets are mainly based on sentient, imperfect beings with strong feelings and precise plans: us humans. This is the main factor that that makes it possible to make a profit. There are also other practical factors: markets lag behind and smooth demand and supply, markets overshoot their motions, markets have an inertia at turning the direction of price, markets are driven by strong entities each with their agenda. All of those are the work tools of the trader.~1~