Hello wonderful aspirants, today we are talking stock markets and the contributor for these two questions is Mr. Balaji Vishwanathan, a person who ran a Fin Tech Company for a few years.
Q: Why isn't the trading day for stocks 24 hours?
A: One of the key purposes of a market is to enable trading at a fair price. To do that we need enough number of buyers and sellers.
Imagine buying vegetables from a bazaar. If the bazaar had only one merchant and a lot of buyers, the seller could charge exorbitant amounts. The reverse is also true with a lot of merchants chasing a few buyers.
The central tenant of capitalism is to have a lot of buyers and sellers who will help bring fairness to both sides. This is why governments go strong on monopolies and why free trade & competition are holy words in a capitalist’s book.
In a stock market, this concept of having a lot of buyers and sellers is brought in a concept called “liquidity” - it means things are flowing rather than staying stagnant. When you go and sell your share of say Google at a time when there is a lot of liquidity, you will get a fair price for it. There will be a lot of buyers and you will have the choice. The same when you want to buy a share of Google.
This is true when the markets are open and the traders of big banks [market makers] are operating. After the working day, most get home or do other activities [such as absorbing information and doing research]. If you attempt to keep the market open past the working day, you will have fewer traders and the price you get might not be fair. Especially, if you are an inexperienced investor not using limit orders, you could get seriously burnt.
If you are an experienced investor you could try other trading methods to trade after hours in the electronic exchanges, but these tools are deliberately kept out of the reach of novices to protect them from themselves.
In summary, trading hours are needed:
- To enable fair pricing through sufficient liquidity
- To enable traders absorb information without panic. Major news like earnings announcement or interest rate changes are thus timed when the markets are closed.
Q: What would happen if people only traded ETFs (Exchange Traded Funds) instead of individual stocks?
A: If everyone traded only in ETFs, the market would lose a lot of reactiveness and pricing capabilities. It would be a very dumb market. We are already seeing the fallout of this in less traded parts of the market.
One of the biggest uses of a stock market is to enable a large group of individuals analyze a variety of companies and use their combined brains to arrive at the right price for a stock. If Apple’s price is overvalued, investors would sell and vice versa. This enables us to quickly react to company performance and leadership & market changes.
Exchange Traded Funds, on the other hand, decide on a basket of shares to buy and they cannot change the basket too much. Even if Apple produced a bad result today, the technology ETF has to buy that proportional to the investment it receives. And vice versa. Thus, atleast in the short and medium term, the performance of Apple would be immaterial to whether its stocks are purchased or sold.
We are seeing this effect in emerging markets. If China had a bad day, Indian, Thai, Indonesian markets would also go down. The reason is that a lot of investors trade through these baskets and pull money in and out of that basket. If they pull out of the basket because one of the components had a bad day, they also take money out of the better performing groups in that basket.
In the long term it probably doesn’t matter as the ETFs can adjust their baskets, but as Keynes said in the long term we are dead.
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