The Market View of C. W. Smith
In a trade, stocks go from weak hands to strong hands, or vice versus.
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Here we consider what the sociologist, Charles W Smith, has to say about the market. The quoted remarks are drawn from his book, The Mind of the Market, published in 1981. Smith wrote a revised edition in 1999, called Success and Survival on Wall Street.
Says Smith, specialists or floor brokers acquire a "corner" on which to trade specific stocks. They conduct business by "keeping book" on orders (from individuals or institutions) to buy or sell stocks in their stable of stocks. In so doing, they create a market for the stocks.
Each "book" is like a piano keyboard. The specialist produces a "note" by matching a seller with a buyer. So he's dependent on the existence of orders and can only go where the orders are. To maintain an "orderly" market, he buys when prices are dropping too fast, and sells when prices are rising too fast. Nevertheless, the orders can be above and below the market, and it's his fingers that do the walking. The tune is his to compose.
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With each trade, stocks change hands and may go from "weak" hands to "strong" hands, or vice versus. In a bear market, says Smith, stocks are typically passing from "weak" hands to "strong" hands as prices move down, and in a bull market, stocks usually go from strong to weak, as prices move up. Smith identifies strong and weak hands, as follows:
A strong hand is one which may be willing to sell at a higher price but unwilling to sell at a lower price; a weak hand is one which is usually afraid to sell at a higher price, but more than eager to sell if the stock begins to decline.
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According to Smith, the specialist's book contains buy orders below the market and sell orders above the market. These are limit orders. The stock price must reach a certain value before a trade can be made.
Stop/loss orders are protective sell orders below the market, and stop-buy orders are protective short covering or anticipatory buy orders above the market.
One would expect that the many buy orders below the market would be bullish for stocks because of the potential support they might provide against downward price motion. And one would think that the many sell orders above the market would be bearish because of the potential heavy supply they create against upward movement. But the odd thing, says Smith:
[Just] the opposite is true
. Stocks move in the direction of the orders. The fact that there are orders to buy the stock if it goes down makes it possible for the stock to go down [just] as orders to sell as it goes up makes it possible for the stock to go up. If there are no buyers just below the market, few people who own the stock would be willing to sell it. [The buyers would demand lower prices.] Similarly, if there is no stock for sale just above the market, there will be few people willing to buy it. [The sellers would demand higher prices.] (My emphases and additions)This is a telling point. It reflects a key aspect of the markets and is worth a closer look.
The orders give the specialist the opportunity to move prices up or down, and if the trades are in his favor, he'll gladly perform the matching ceremonies. But how can we know where the potential trades are? How are we to know which direction he will take? Smith wasn't himself addressing these questions, but his comments are still relevant.
[An order] to sell a stock above the market reflects a degree of skepticism in a bullish environment, whereas orders to buy below the market represent confidence in a bearish environment. One only finds significant orders to sell above the market when the market is moving up and significant buy orders below the market when the market is moving down. (My emphases)
This view may be summarized in the assertion that the market climbs up a wall of worry and falls down the slippery slope of hope.
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The following sheds light on the matter of weak versus strong hands:
When the crowd is buying, it is the cooler heads who are selling. As long as there are enough cool heads who are willing to provide stock, the stock is likely to go up. When the crowd owns all the stock, there is no one left to sell. When that happens the stock has peaked. Usually there are still plenty of people out there willing to buy, but they are not willing to pay any price. … There are limits even when playing follow the leader.
Throughout an upward movement of a stock, there will always be those who will follow behind: people who will be bidding below the market. As long as there are persons willing to sell their stock slightly above the market to the more aggressive buyers -- those willing to pay an extra eighth -- the presence of these followers is not felt. When the cool heads are gone, however, there they are waiting to provide the down stairway for the stock. Their optimism is as necessary for the decline of the stock as was the skepticism of the original owners.
The situation with those stocks which maintain their advance is quite different. In their case there is usually some "rational" reason for the initial move. The crowd view insofar as it exists is normally that the upward move is not justified. Those playing follow the leader begin to sell; it is the cooler heads who are buying. Eventually even those stocks will peak out, but providing a new crowd hasn't formed which now believes the stock will never stop going up, most who now own it will want to own it even if its rapid upward movement should cease for a while. Furthermore, since the crowd view would still be that the stock is, if anything, overpriced, there is not likely to be heavy demand for the stock below the current market. (C. W. Smith)
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On occasion, the opening price of a stock will gap upward or downward from its closing price of the day before. On an up move, for example, it may jump from 30 to 35, when it normally trades in fractions. In such a significantly different trade, it would skip over any intervening limit orders to buy, but eventually it would retrace its movements to fill the "gap," as the saying goes.
The reason for this, according to Smith, is that those who missed it at 31, 32, 33, and 34 would likely bid for it below the market. "They might have to wait a while, but sooner or later their impact is usually felt." In other words, I gather, the market will, again, follow the orders down.
A similar argument would be made for a stock that gapped down, except that now any bypassed limit orders to sell would be revisited, taking the market on an upward move to fill the gap. We have recently seen quite a few major stocks gap down, and others gap up, in what seems like a continuation of stock rotation. Eventually, it is argued, these gaps will be filled, even though it may take months or years.
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