Part 1 explained the basics of what a stock is.
In Part 2, I will explain how stocks are traded.
1. When the ship has departed
The merchant ship has set sail. Now, all the investor can do is wait until the ship returns.
At that time, it took at least six months for a ship to return, and right after the ship left, the stock was not very popular. Since it had just departed, no one could know how much profit it would bring. But then, a letter arrived.
“We are bringing back twice as much pepper as last time!”
This news begins to spread.
2. Expectation-driven price increase: the beginning of trading
Buyer A: “Hey, if you sell your stock to me, I will pay you twice the amount you originally invested!”
Buyer B: “I will pay you three times!”
I am holding the stock, and people who want to buy it keep raising the price even though I am not selling.
The market price of the stock keeps rising, but since I am not selling yet, I still have not received double or triple the value.
When the stock rises to ten times the value, I make a decision.
“I will sell!”
The trade is executed, and even though the ship has not yet returned, I earn ten times my initial investment.
3. The concept of false trades (false trade) and actual trades (actual trade)
Here, an important concept comes into play: false trades and actual trades.
A false trade refers to the price rising without an actual transaction occurring, while an actual trade refers to a transaction that is actually executed at that price.
People trying to buy and continuously raising the price when I am not selling — this is a false trade.
When the price rises and I actually sell — that is an actual trade.
Although there are many false trades, once I sell at that high price, the false trades turn into actual trades.
Expectations that the ship will bring back a large amount of pepper generated many false trades, and the stock price rose.
4. When many investors exist: the essence of trading volume appears
Let’s continue to the next point.
The previous example assumed that I was the only person holding the stock.
But what if a huge number of investors had invested in the ship?
Here, we can understand the essence of trading volume and false trades.
A trade occurs when a buyer pays a price and the holder of the stock sells it.
5. Different investor choices: the difference between false and actual trades
Buyer A: “I will pay double! Sell to me!”
Investor A: “Alright. Although the ship is said to bring back twice as much pepper, I cannot trust it, so I will sell!”
Buyer B: “I will pay double! Sell to me!”
Investor B: “Alright. I agree with Investor A. I will sell as well.”
I am waiting to earn a tenfold profit, but other investors are selling at much lower prices, so the price is not rising, and I must continue to wait.
6. What impact do investors A and B have?
Here is a question to consider:
Did Investors A and B make a rational decision?
There are 1,000 additional investors besides A and B. The fact that these two sold — does it persuade everyone else?
Of course not.
It merely reflects the doubts of two individuals regarding whether the ship will return safely.
The remaining investors are still waiting.
7. What trading volume reveals about false trades vs actual trades
The key to distinguishing false trades from actual trades through trading volume is determining whether the number of people who actually traded at a given price is small or large. (This is extremely important.)
In Part 3, I will explain the fundamental meaning of trading volume.