Stock Market and Investment

General perception of the stock market seems to neglect an extremely important part of it. When someone MAKES a lot of money, that money is not printed to supply it! Someone else often lost a similar amount!

The stock market and the commodities market continually show varying prices for each of their constituent parts. These variations are the central reason for there being so much interest in the stock market. These variations can be divided into two major categories:

This last is the subject of these comments.

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Some time back, shortly after publicity over Microsoft's loss of its court case with the government, the stock market had extremely active and turbulent times. In a single day, the market had dropped over 500 points only to rebound to only have a small loss for the day. More recently, the Enron and WorldCom (and many others) debacles created similar effects. News reporters describe how trillions of dollars had "vanished" in a matter of hours or days or weeks! Let's look at just what happens to cause such things.

During the loss of that Microsoft morning, nearly 100 billion dollars of value vanished! What does that mean? It means that a large number of sales of stock shares were made that morning, for amounts that were substantially less that those stocks were worth at the beginning of that morning. When they were sold for the lower amount, the sellers effectively took losses. So many shares were sold that morning, that the total losses represented the 100 billion dollars. Later, in the afternoon of that same day, the stock prices rebounded, and investors who had bought at the low prices were able to make great profits, most of 100 billion dollars.

The people who had SOLD in that morning LOST the hundred billion! The people who later BOUGHT that same afternoon PROFITED by that hundred billion dollars! (No "new" money existed that day to provide those profits!)

Much of the modern stock market is extremely automated. Mutual funds representing the combined assets of many investors, buy and sell huge quantities of individual stocks minute by minute. They tend to do very well in such turbulent markets, and they generally make large amounts of money in very short periods of time. Then, when the market has periods of reversals, they often have already sold and are waiting to buy the same stocks again after the price has dropped.

No one is printing money to supply these large profits. Where does the money come from? It seems absolutely overlooked by investors and by market "experts" that in such short-term situations, for every dollar made as profit, a dollar had to have been lost by someone else as a loss!

On that recent day, nearly 100 billion dollars was lost by the totality of investors that morning. Many of those billions of dollars were later earned back by the same or similar Mutual funds in the afternoon, but whatever wasn't, HAD to have been lost by small investors! In the situation of a short-term variation, it is a closed system, with exactly the same total losses as gains.

Mutual funds and the other very large-scale investors, have the advantage of up-to-the-minute or even up-to-the-second news and information about everything and anything that could affect the value of the stocks they buy and sell. They are able to get in and get out very quickly. Individual investors are at a tremendous disadvantage in this regard. As that recent day demonstrated, an investor that got news that was even a few hours old could have (and often did) lost large sums of money.

The long-term trends of the stock market are different. That is a situation where there does not have to be any "losers". It is possible for virtually all investors to gradually profit from a market that continually increases in real intrinsic value. The situation being discussed in this essay is specifically the short-term variations and the profits and losses from them.

It seems amazing that investors do not seem to be aware of this basic fact. They only think about (and mention) the up side, the profits that are made. No one seems to be aware that virtually the exact same amount of losses must necessarily also occur. And, considering the advantageous position of the large-scale investors and Mutual Funds, the reality is that there are generally necessarily far more losers among small scale investors than there are winners.

There are parallels in our society that exist. State lotteries take great pain to promote their numerous games and the spectacular amounts that a winner will receive. They NEVER publicize that they collect two million individual one-dollar bets before paying one million to a winner. The winner gets great publicity and fame. The two million losers don't seem to worry much about it, because it was "only" a dollar! No one seems to comprehend the enormous number of these "small" losers, but it is a fact of reality that they MUST exist. As in the stock market situation, the state does not print new money to pay off a winner. Those funds are ALWAYS supplied from the bets of the losers.

Other parallels exist in our society. One day, my ex-wife got off the phone with her brother and she was bubbling with news about how he had just made $30,000 in one day! He was a real estate salesman. He had earlier been contacted by an elderly woman who decided to sell her house after her husband had died. As an elderly woman, she was not in a very good position to know the true value of her house, and somehow she came to decide to sell it for $26,000. My ex-wife's brother apparently knew that it was worth well over double that, but he did not inform the elderly lady of that knowledge. (I found that incredibly unethical!) Immediately after she listed it for $26,000, he personally bought it! He them immediately listed it for around $56,000 and sold it promptly.

My ex-wife was very proud of her brother for "earning" so much money in one day. I was disgusted with him. She just saw the up side, where he suddenly had $30,000 clear profit that he didn't have the day before. I never could get her to understand that he effectively cheated that elderly woman out of that $30,000, by not informing her that her house was worth far more than she thought. As far as I was concerned, he didn't "earn" anything that day, but merely found a tricky way to transfer $30,000 of assets from the elderly lady to himself. No new money came into existence to create his profit. In order for him to receive that money, the elderly lady had to lose that much in value of her assets.

Rather than ONLY present and discuss the profitability of investing in the stock and commodities markets, it seems much more ethical for brokers and investment analysts to also mention the enormous scale of the losses that necessarily occur in those markets every single day!


This presentation was first placed on the Internet in August 1998.

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C Johnson, Theoretical Physicist, Physics Degree from Univ of Chicago