Contrary to what most people believe, it’s not the Fundamentals or even the Technicals for that matter. Uh-oh, I’m about to piss a lot people off. I can already feel it. But, it’s true. The Fundamentals, the Technicals, the changing of the wind… none of that is what actually moves the price of a Stock.

The Stock Market Is An Auction

What happens in an auction? You’ve got a large group people bidding against another large group of people, and you’ve got another group of people selling to the bidders.

For instance, at Barrett-Jackson there’s typically 1 car being offered at one time, and at the same time there’s multiple buyers placing their bids to try to purchase the car. Thus, as the buyers place their ever-increasing bids, the price rises until there’s the highest bid wins out. That’s the plain-vanilla version of how an auction works.

 

The Stock Market acts in the same manner, with very slight differences. The differences being that not only can you enter bids on the Stock you would like to purchase, you can also offer shares to sell (regardless of whether or not you’ve ever actually owned the Stock. It’s called Short-Selling).

Unlike having a single car being offered at one time, the Stock Market allows for multiple offers to occur at the same time, therefore the market does not go up and up forever because there is a counter-auction taking place with the sellers against the normal auction happening amongst the buyers.

In other words, there is an auction amongst the buyers that drives the price up. Conversely, there’s a counter-auction amongst the sellers that drives the price down.

In a moment we will talk about how the inventory positions of the buyers and the sellers can drive market reversals. Ever heard of “short in the hole”? Or “long in the tooth”?

The Buyer Moves Us Up… The Seller Moves Us Down

It’s pretty obvious, isn’t it? Multiple buyers bidding against each other is what causes a market to move higher. Multiple sellers fighting against each other causes the market to move lower.

I don’t really like to label this Supply and Demand though. I think that phrase is used way too often, and somewhat cheapens the significance of this reality. It makes it sound so blasé.

If we operated in a market where there was a fixed supply (oh no, there’s that word) of sellers, then the market corrections that we experience and the pullbacks would be nonexistent.

The opportunity that market participants have to short-sell, and/or make multiple competing offers against other market participants offers, allows for the market place to be efficient. After all, the current price is what’s considered fair, right? I guess it depends on your definition of “fair price”.

In the article 7 Things to Consider Before Using a Trading Simulator, I talk about this very idea and how unless you’re actually buying and selling in the marketplace, you have no real influence in the market. Opinions don’t matter. Price is what matters.

Here’s a price ladder of GS. You’ll notice that the last price that GS traded at was $244. There’s orders to sell 300 shares at $244.08 and 200 shares $244.11.

If someone were to come into the market (for whatever reason), and purchase 500 shares of GS with a market order, then the last traded price of GS would rise to $244.11.

Make sense?

The Inventory Positions Of Buyers And Sellers

Have you been to the supermarket lately for some grocery shopping? Probably. What did you see? Rows and rows of food that was nicely stacked? Probably.

What you saw was the store’s inventory.

The store buys inventory at a certain price, and then they sell that inventory to others at a higher price. When the store is out of inventory, it buys more. When the store has too much inventory, it puts a sales sticker on it and lowers the price so they can get rid of it faster.

The Stock Market operates in the same way. It is the inventory positions of the Buyers and Sellers that causes them to either buy or sell. Fundamentals and Technicals come second. We’ll talk about that more in a moment.

But think about it. If you’re Long too much Stock relative to your overall portfolio, you’re most likely unbalanced. You have too much of that Stock in your inventory (your portfolio), and need to get rid of it. How do you do that? You sell some of your Stock. If you can’t sell it at your price, you lower your price until someone buys it from you.

This works the other way around too. When you hear the term “Short in the Hole”, that refers to a massive amount of short sellers in a certain Stock. This can be a dangerous situation for new “Shorts”, because the odds of a violent Short Squeeze happening is high.

Is this idea starting to make more sense now? The liquidation breaks, the short-covering rallies… These are both extreme moves that happen in the opposite directions of the most recent price action. For instance, on a Stock decline you might get a huge rally in the Stock that seems to come out of nowhere. The trick is to know whether that was Short-Covering, or new buyers bidding up the market.

Why do they occur? It’s because the market was either too Long, or too Short, and needed to correct itself. The market players needed to correct their inventory positions, and the savvy traders who caught on early probably faded the move and made away like a bandit.

“Everyone says you get killed trying to pick tops and bottoms and you make all the money by catching the trends in the middle… I have often been missing the meat in the middle, but I have caught a lot of bottoms and tops” – Paul Tudor Jones

Comparing Fundamentals/Technicals To Inventory Positions

Okay, what most of you have been waiting for. My explanation of my ludicrous comments earlier, right? Yeah, sorry to disappoint. Not going to happen. However, I will talk about it a bit more.

The reason that I say that Fundamentals and Technicals are secondary to inventory positions is that if you were to choose which one to focus on, my vote would be to focus on identifying inventory positions of the buyers and sellers. Here’s why.

The Fundamentals and Technicals are what motivate the majority of buyers and sellers to form opinions about the market, and then trade accordingly. However, the Fundamentals and Technicals can lie. Inventory cannot.

In other words, actions speak louder than words. It’s easy to talk about what you think is going on in the market through Fundamentals and Technicals, but volume and price are what really matter if your plans are to make money, rather than feel good about your fancy opinion.

Moreover, the issue that I have with most kinds of Technical Analysis is that it tends to look at historical prices in a vacuum that is absent of the tempo and rhythm of how price came to be. This leads me to my next point…

The Dark Art of Tape Reading

A lot of you might be thinking I’m out of my mind here. I can see how some might be thinking that. My opinion here might seem like hogwash, or voodoo to some (Or “malarkey” to Joe Biden). The closest thing I can compare my view of the market to is the “dark art” of Tape Reading.

There’s a few different views on how Tape Reading is done (I guess that’s why it’s an “art”), but mainly it’s just learning how to read Volume and Price over Time. Tape Reading is different from Technical Analysis in that there is a rhythm and tempo to the tape that isn’t necessarily apparent in historical price charts.

Now I know for a fact I’ve lost some of you with that statement. You’re thinking this guy really is crazy. Well, just remember trading is both an art and a science. I’m talking about the art of it here.

Tape Reading is akin to reading the inventory positions of the market participants. It’s how you identify areas of potential reversals (or imbalances) where other people have gotten themselves short in the hole, or overly long.

“When it comes to trading macro, you cannot rely solely on fundamentals; you have to be a tape reader, which is something of a lost art form” – Paul Tudor Jones

Tape Reading is also thrown out by a lot of traders who focus on Fundamental Analysis.

Here’s the thing though… the only thing that matters in the market is buying something for a lower price than where you sell it. If you ignore the inventory positions of the other players in the market, if you ignore the tempo and rhythm of how price came to be, you might very well be buying an “undervalued Stock” at its current high right before a major pullback.

Now I know the argument with most Fundamental traders/investors is that “well I’m holding this for the long haul”.

Okay, good for you.

But I would be “short” your emotional staying power in that “undervalued” Stock given that human nature is loss averse and you will most likely bail on holding that losing position (no matter good the Fundamentals are). Then when that “undervalued Stock” finishes its price correction and continues higher, you’ll be kicking yourself.

I’m not saying Tape Reading is perfect. It’s just something that shouldn’t be so easily dismissed, like it is with so many other schools of thought.

Conclusion

The activity of Buyers and Sellers is what moves a market. The reasons that someone might buy or sell comes down to their view of the Fundamentals or Technicals. However, it is not the Fundamentals and Technicals that move a market.

It’s easy to have an opinion, but your opinion does not move a market. The buying and selling activity is what is most relevant.

Anyway, I hope this was in intriguing article for most of you who stuck through it. If you would like to continue the conversation further, or tell us what you think, drop us a comment below.

Thanks for reading.