Lesson 2: The Structure of the Stock Market | The Absolute Beginner’s Guide
Sometimes nothing is something.
When Apple announced its stock split, its stock price soared. Look at the chart below (which also includes obvious good news in the COVID pandemic).
The weird thing about a stock split is that, say in a 2 for 1 split, you get double your stock at half the value. If you had one share at $200 before the split, then after you have 2 shares at $100 each. It changes nothing, at least in theory.
But in practice, it makes the stock easier to buy for people. Rather than pay $200 a share, newcomers only pay $100. It also makes certain advanced moves, like options trading, easier too, since each option represents the value of 100 shares–and with a lower price, those options are cheaper. Finally, it creates buzz.
This is just one example about how market mechanics do strange things to the price of stocks and cryptocurrencies. Sometimes no change (in the fundamentals of a company or coin) results in change (in price).
In this newsletter, I’m going to review what the stock market is, how it functions, and why a move called an Exchange Trade Up can result in 100% returns when literally nothing about the company or coin changes.
I’ve told my paying Subscribers about moves with the cryptocurrency market that just this week resulted in a 40%+ jump in $DOGE. My Daily subscribers even learned about my plan to trade out on that bounce.
Even they will learn from this lesson though, since it can help them understand why I’m looking at specific trades.
As a note, basically everything that is going to be developed here for the stock market holds for cryptocurrencies, so I’m going to talk about stocks for the most part. Let’s dig in.
What Exactly Is “The” Stock Market?
When people talk about “the” stock market, they usually mean a well-recognized index like the Standard and Poor’s top 500 index.
The actual stock market is just the global market for buying and selling stock, which is a share of ownership, in publicly traded companies. Each country has its own laws around buying and selling publicly traded stock, but these companies all have to go through a special legal process to make their shares available for purchase.
An index, like the S&P 500, is a well defined and carefully selected group of companies that are thought to represent the best business available publicly. They represent the conventional wisdom in which stocks are “smart.”
Investing strategies are then tested against the returns of these indexes. Basically, if your strategy doesn’t return better than the S&P, then your strategy isn’t better than the conventional wisdom about the stock market.
So, for the most part, when people talk about the stock market, they usually mean the S&P 500 ($SPY), the Dow Jones Industrial Average ($DOW), or the top 100 companies in the tech-heavy Nasdaq ($QQQ).
Why Do Companies Go Public?
The short answer is also the truest: to make a lot of money.
When you own a company, whatever earnings are retained (= all revenue minus all expenses and taxes) become the value of that company’s stock.
The problem is that it’s really hard to sell private stock to anyone. You have to find someone who wants to buy it and you can’t do much with it unless you buy enough to own the company. This is why small mom and pop shop owners tend not to buy and sell their stock often.
As a result of this difficulty finding buyers, private company stock, called private equity, usually sells at 3x-8x the company’s annualized earnings when the company as a whole finally sells.
Nerd Note: private equity usually sells at 3x to 8x of the seller’s discretionary equity, which is defined as net earnings + whatever the previous owner was getting from the company in wages and benefits. So if the owner was getting wages, then that counts as part of the seller’s discretionary equity. If they had a company car, that also counts.
To make things simple, if Local Mom and Pop Shop made $1,000,000 in earnings one year then it might sell the company for $3,000,000 in the private equity market.
When a company becomes a publicly-traded company, by contrast, it usually can sell for 15x those earnings and sometimes even more.
Clearly, $15,000,000 is a lot better than $3,000,000.
And to be clear, this difference in payment is a result of public v. private listing. The main reason is that a public company’s shares are easier to buy = higher demand = high price.
What Happens When I Place A Buy Order?
You can already see how public stock prices respond to demands. The reason is that a market is like an auction where each stock has an auctioneer. One party asks for a certain price, say $101 dollars, and another party bids to buy it, say at $100.50.
When you actually place an order, you are not only buying the stock, but also setting a precedent. If you agree to the $101 asking price, then the auctioneer has a reason to expect the next person to pay more.
The ask price might go up to $101.50. And if someone buys that, then $102 … and so on. That is how stock prices rise.
Now, it matters how many shares you are trying to buy, because 1 share doesn’t make for a lot of demand. But 100,000 almost certainly will. As a result, when you place a buy order you will move the price up.
If you get a fancy display of the stock market, say through a professional platform, you’ll actually be able to see the 40+ exchanges used for buying and selling stocks in the US, and how big each bid is on each exchange. You’ll be able to see, as a result, when a big purchase is coming through and how other traders are reacting to that.
So, even bidding or asking–not completing the transaction–usually moves the market just a little bit because it indicates increased (or decreased) demand for a stock (or coin).
All of this leads to the real concern: how demand for stocks is affected by the exchanges they are on.
The Exchange Trade Up – With Stocks
Some stocks, those that usually have an ‘F’ at the end of their ticker, aren’t on major exchanges. US cannabis companies like $GRAMF–which owns Jay-Z’s Monogram–don’t trade on major exchanges. These are the companies that would have been traded on old-styled pink sheets.
In the case of cannabis companies, it’s because they cannot legally satisfy the requirements necessary to be placed on a large public exchange. They can’t have traditional bank support, among other problems. For a lot of other ‘F’ companies, they are too small to be listed–this would be the real fate of Local Mom and Pop Company.
The result is that they usually don’t trade at 15x their earnings. They quite often don’t trade at much more than private equity numbers, maybe 3x or 4x. That means that their share prices are often less than a dollar.
They are, as a result, penny stocks.
But it’s not the price that makes them a “penny stock” so much as their restricted exchange access. As soon as they satisfy the requirements to get larger exchange access, say on the New York Stock Exchange (NYSE), then they’ll get a huge boost in demand.
Currently, I’m hoping $VYGVF is able to do this. That’s the stock for Voyager, the “Coinbase Killer.” They offer free trades, which is cheaper even than Coinbase Pro, if you live in the US but you don’t live in New York.
Currently, they are working on getting their NY Bitlicense, and once they do, they’ll not only be able to get customers from NY, but they’ll be able to apply for listing on the NYSE.
Using Coinbase, as a basis of comparison, shows that such a move would effectively double their share price without changing anything about the company’s actual profitability.
Just relisting on the NYSE would likely give you a 100% profit. That’s why I like this stock as long as Bitcoin’s trendline remains ok.
The Exchange Trade Up – With Cryptos
The same thing happens with cryptocurrencies, but they offer a twist.
What’s the same is what you are going to witness with $DOGE. They are about to list the coin on Coinbase. When that news came out $DOGE jumped a lot. Musk also Tweeted about the same time, so you saw a 40% jump in about 24 hours.
I think it’ll jump again when people can buy it on Coinbase.
The inverse happened when Elon first Tweeted about not accepting Bitcoin for Tesla cars because he was worried about environmental damage. That made the market go on the hunt for environmental coins.
The smallest junk coin that had relatively easy access–BitGreen–did 12x in about 10 hours. Here’s its chart.
I actually posted about it on Quora, but it was late at night and I went to bed before I could set up another account on an obscure exchange to buy the coin.
Instead of waking up to what would have been a 10x gain, then, by the time I realized what had happened, the pump had dumped.
The moral of that story is this: restricted exchange access created a huge pump, but also led to the coin’s price demise because there was no wide group of possible buyers.
Concluding Thoughts
So, that’s the lesson.
- “The” stock market is actually an assembly of markets.
- People often confuse the “stock market” with a major index like the S&P 500.
- Buying and selling changes demand for a stock, which changes how many times earnings–called the multiple–the stock trades for.
- When a stock moves to a bigger exchange with more demand, its price can double pretty quickly, even though the company is not any different than it was before.
- The same thing can happen with cryptocurrencies, with a twist: some cryptos can actually benefit from restricted access. But that restricted access also makes their pumps very short-lived.
Those last two points explain ways that price moves without any relationship to the earnings of a company (or value of a coin). They explain how you can make 100%, or even 1000%, without anything actually changing.
Obviously, for my subscribers, I try to tell them about both the short term pumps and the longer-term exchange trade-ups. But the only ones that prove reliable are exchange trade-ups.
That’s it for this week. Happy Trading!!
Disclaimers
General financial disclaimer: This post is provided for entertainment purposes only. I am not giving you financial advice and I am not a financial advisor. You should expect no financial returns one way or another based on my statements. These points hold equally for any statements that could be attributed to The Art of The Bubble or any related business entities. If you decide to buy or invest in anything, then your returns and potential losses are your own. No statements about taxation are taxable advice and you are encouraged to consult your own tax professional. You are also encouraged to do your own due diligence before investing in anything.
Specific disclaimer: I own more stocks and bonds than I discuss here, but they are not relevant to bubble trading. Anything that is relevant, I let you know my position in them through the charts above.