Investors, Speculators and the Stock Market

Due to its length this article is being published in two parts; Part_1 is available on this same site.

If you find it hard to compare the gambling in Las Vegas with the gambling on the New York Stock Exchange, consider the activities of each. In Las Vegas you enter a gambling casino, exchange dollars for tokens or chips and proceed to wager that certain events will occur according to your predictions. When you put money on a number at Roulette you are predicting (or at the very least hoping) that the marble will stop on your number. When you place bets in a card game you are predicting that your cards count higher than others’ cards, in your game. When you put coin or tokens in a Slot machine you are predicting that the machine’s parts will randomly align themselves in such a way that more money will be returned to you than you will put into the machine. All of these activities are called gambling because you are spending and receiving items of value, money; and because you may only do so legally if you cannot accurately predict the outcome of your wagers. For every winner there is a loser, if the house is the winner then the customer is the loser, and vice versa.

If you choose to place wagers on the New York Stock Exchange, you must also place money at risk and presumably be as ignorant, or at least as deluded, as other players. First you hire a broker and put money into an account, from which your broker can deduct funds when you wish to buy stocks, and into which your brokerage can put your winnings, should you be so lucky. You may contact your broker and tell him or her which stocks you would like to buy, and how much to pay. You now own a piece of some company, and your voice counts in managing your corporation, according to the percentage of ownership in your name. Your bet is that your workers and management team are going to out-produce the competition, make greater profits and return a larger dividend to you. If your corporation does do better you not only win with dividends, but your shares of stock are likely worth more than you paid. Other potential players will see the stronger position of your corporation and some of them will bid more money to buy into your game. If you should decide to sell your stock allowing someone else to take your place and risk, you will receive more money than you paid. This profit is called a capital gain.

If you guessed wrong and your corporation operated inefficiently and lost money, you would not get a dividend, and your stock might drop drastically in value, because more owners may want to sell than there are would-be owners waiting to buy. Sellers are forced to accept less and less for their stocks, potentially resulting in great losses for some. For every one who wins someone else has lost. The big difference in these two gambling industries is the length of time between wagers and the determination of profit or loss.

Brokerages that facilitate stock, bond and commodity trading, operate in a similar manner and purpose to companies that operate gambling casinos. Brokerages do not care if the markets go up or down, so long as trades are being made. The brokerages charge a fee for each trade; the more trades, the more income for brokerages. In gambling casinos the odds of winning slightly favor the casino owners when one bets against the casino; and the casinos charge players a fee for the use of their facilities when players gamble with each other. The casino owners’ interest also lies in the volume of gambling; the greater the activity, the greater the income for the casinos.

Brokerage firms reap their wages and bonuses through fees from the number of stock, bond, or commodity transactions occurring. If the markets are sluggish, with relatively little trading going on, brokerages can buy and sell stocks and bonds with other brokers, kiting stock, bond and commodity values and thereby creating a mirage of investment activity. This practice is very old and is called, “Churning the market”. This is principally done to provide them with cash flow and protect their stock, bond and commodity portfolios, since their net worth (and the value of their own stock) is tied to cash on hand and market value of their investments. This churning hurts on-going investment activity, because it prevents the markets from moving lower and allowing investors an opportunity to purchase stocks, bonds and commodities at a true market value.

In the United States there are three principal markets to buy and sell stock. The New York exchanges are the primary market, and the over the counter exchanges are the secondary market (NASDAQ). There is another exchange market for stocks and bonds that is referred to, as the “Third Market”. The third market is a partial joining of these two markets to facilitate the selling of large blocks of stock. Which if they were offered through an exchange to individual investors would crash that stock’s value, along with its paper equity, and could create large declines in the overall market if not panic and chaos.

The third market is composed of brokerages that will buy large offerings individually, or in concert with other buyers, at a set price and then resell it in small lots in the usual manner. Though the set price for these large sales is determined by prices set at auction in the exchanges, this stock is not being auctioned. It is being sold in a manner contrary to the rules of the exchanges, that all stock sales be offered in public via an auction to let buyers and sellers determine market price and value. The seller of a large block of stock is guaranteed, through the third market, to receive the highest possible price for such stocks or bonds, at the expense of unwary buyers in the regular auction markets. One person’s loss is another person’s gain in these markets. In the public exchange markets, if a large block of stock is offered at a price no buyer is willing to pay, it will then remain unsold or only a portion of it will sell. If it must be sold, then the price must drop until buyers agree that it has dropped to its proper value, according to supply and demand in a free market. The third market is just a creation of a controlled market to allow brokerage firms to protect the value of their own holdings and to prevent investors from profiting when other market-players’ must sell.