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Friday, September 9, 2016
#Market's Beware: Shoeshine Boys Are Advising Again
So it's important to watch him very closely
Q: How much is my house worth?
A: Whatever the highest bidder is willing to pay for it.
Those of you who took an introductory Economics class in high school or college may remember learning that prices are set "at the margin". That's a fancy way to say that prices are set by the person (or people) willing to pay the most.
This person willing to pay top dollar is called the "marginal buyer". Most of us don't really think about him much, but he (or she) is very, very important.
Why? Because the marginal buyer not only determines price levels, but also their stability and degree of volatility. The behavior of the marginal buyer, as well as the degree of competition for his/her "top dog" spot, sets the prices of nearly every asset class held by today's investors.
Imagine for a moment an auction room, filled with people holding their bidding paddles. A rare Picasso painting is brought to the block. Paddles all around the room compete furiously as the auction starts; but as the bid price rises higher and higher, fewer and fewer paddles participate in the bidding. Pretty soon, it's down to just two bidders dueling back and forth with one another. Then, after a stunningly high bid of $106.5 million dollars, no more paddles are raised. The marginal buyer has been found. No one is willing to outbid his price. (For the record, this is exactly what happened back in 2010 when Picasso's Nude, Green Leaves and Bust came up for sale.)
This example contains several important elements for price-setting. First: the marginal buyer's last bid is what ends up setting the final price. And second: the intensity of competition determines how high the marginal buyer's bid will go (if no one else was willing to offer more than say, $10 million, it's unrealistic to expect that the marginal buyer would have still put in a bid as astronomically high as $106.5 million).
Now imagine what would have happened if our marginal buyer above hadn't shown up for the auction. Maybe he got stuck in traffic, or decided he'd rather own a tropical island instead of a wall hanging. How much would the painting have sold for then?
It would have sold at a price lower than the losing bidder's last offer. Without our hero in the room, the losing bidder would have become the new marginal buyer. And without the threat from a competitor with deeper pockets, it's quite likely our new marginal buyer would have been able to secure the painting at a substantially lower price.
Not Good For Stock Markets -
Low Volumes Means Fewer Paddles
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