The Stock Market Environment

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As a trader you are an integral part of a world market environment that could provide steady sailing through calm seas or backing and filling in massive waves and crosscurrents. Operating within this arena and its ever-changing physical and social atmosphere, you'd like to select safe, but mainly profitable trading vehicles.

Given this problem, you need to know the terrain -- the conditions that prevail, how money is bouncing around, and what opportunities are open. Pushing the climate analogy to the limit, you could otherwise travel blind and risk being washed overboard, should the business be just a bloody mystery.

To find out what the "weather" is like, you need measuring instruments. You need to develop a weather map and measuring concepts -- a model or framework for your trading decisions. Not easy.

The trading complex has only one role: to act as a vehicle for the purchase and sale of securities -- stocks, debt instruments (bills, notes, bonds), currencies, commodities, and market indexes.

In the trading environment we can distinguish between the foreground of instruments for doing business and the broader background of physical and social factors that can affect how trades are struck. For a general treatment of the structure of behavioral environments, see book. Click here to see ways to take advantage of the conditions.

Over centuries of trading, an organization has evolved whose purpose is to allow trades to be made legally, with all the benefits and responsibilities implied. The vehicle provides trading mechanisms and determines how trading occurs. The components include:

• The business community that provides the shares of stock to be bought and sold.
• Brokers who serve as intermediaries in the buying and selling.
• Brokerage firms that hire brokers and collectively bring buyers and sellers to the market place.
• Stock exchanges through which trades are consummated.
• Trading specialists through whom you make your trades and final arbiters in the bidding game for shares.
• Floor traders, or members of the stock exchanges, who trade for themselves.

Looking beyond the ready instruments, consider elements that determine market behavior less directly but more significantly and form the physical and social background of the markets. Robert R Prechter believes this social backdrop is the primary influence on traders, forming the buying or selling mood. So does Charles W Smith. The background includes consumers, non-publicly traded shopping centers, government agencies, schools, and the like.

It includes the world's economic conditions, ethnic and religious factors, terrorism, wars, weather conditions like pockets of drought or monsoons, natural disasters like earthquakes and hurricanes, and other calamities such as famine and epidemics. Changes in these conditions lead to changes in the securities markets and offer trading opportunities.

We can also identify:

• Economic factors like consumer sentiment and inflation
• Long-range social phenomena like growing technologies and changing population characteristics (such as aging and economic status)
• Short-term seasonal market conditions, like the four-year presidential cycle, year-end tax selling, Friday evening-up operations, or the end-of-quarter window dressing that often occurs in the last week of March.

The relationships and measures of the market environment, like credit balance, cash reserves, advisor sentiment, among others, are identified as market indicators.

The other aspect of the trading environment concerns the trades themselves. In tennis you strike the ball; in the stock market you strike a trade. The trades form the link between the individual trader and the market environment in which the trades occur. Like the moment when the tennis racket strikes the ball, the trade is where the rubber meets the road, the moment of truth. So we get market dynamics, defining the real flow of money.

One way to see what traders are doing is to examine price charts of the markets. By "reading" such charts, we can learn market trends, whether, say, stocks are moving up, down, topping, or basing. Some price charts provide trading volume figures, from which you can tell whether volume is unusually heavy, or not, and whether investors are buying into a stock or dumping it.

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Among the market elements are the companies that make up the business establishment. Of special interest are the public companies, those that issue trading elements like ownership certificates in the form of common and preferred stocks and indebtedness paper in the form of bonds (corporate bonds). These companies prepare annual reports on their business and earnings, to let us know how they're doing and what they have planned In other words, they market themselves and their stocks and bonds.

For a broad range of information on the financial aspects of the business community, you might consult Financial Information Sources.

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It's the brokers who retail company stocks and bonds. They work for brokerage firms and are presumed to bring buyers and sellers together to negotiate a trading price, though it seems we trade with specialists, not with each other (Richard Ney). Brokers share service fees with the house, and more often than not sell stocks owned by the house.

Brokers aren't of the same mind toward, and dealings with, the market -- the differences help to make the markets. They have different opinions about what is and isn't important, and most are just as muddled as the rest of us. That's not very encouraging for the novice, but you have to face the fact that brokers make their money in commissions. Many tend to rely on in-house researchers and advisors and commonly tout the holdings of their firm.

See Charles W Smith on broker types and his view of trading dynamics. See also Ney's view of the trading dynamics.

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Brokers and their assistants and supervisors typically work for brokerage firms -- like Merrill Lynch, say. These organizations are public companies and have their own listed shares. Their business is to buy and sell stocks, and their aim, like that of all other business, is to make money. Their income is derived from various sources, including a percentage of their brokers' commissions, interest derived from the cash holdings in their customer accounts, and capital gains on their own stock holdings, among other things.

Since they make much of their money by selling their own shares, it's natural for them to tout the shares and to be perennially bullish. Also, since a great deal of money is at stake, they can take severe steps to censure analysts who look with disfavor on their stocks.

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Brokers perform their functions in the secondary markets, through trading exchanges, like the New York Stock Exchange (NYSE), the AMEX, the Pacific Coast Stock Exchange, the Philadelphia Exchange, the Foreign Exchange Market, or the NASDAQ. The exchanges are formal meeting places for companies with stock to sell.

A public company gets to "list" its stock with an exchange if it meets certain conditions set by the exchange. Most of the stocks that don't satisfy the requirements are among the unlisted or "pink sheet" stocks. They are usually small, start-up companies with insufficient capital and inadequate earnings history to satisfy the requirements of the major exchanges.

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Within the aggregate of stock exchanges are the market makers, members of the exchanges who either own or lease their memberships -- seats. They are commission brokers, specialists, floor brokers, and others who mostly trade for their own account.

• Commission brokers are members who represent brokerage firms that deal with the public, and they only handle orders that originate away from the floor. This could be a customer trading through a registered representative of the firm.
• Trading specialists are members who make markets in their own small group of listed stocks -- like IBM, General Motors, General Electric, or Microsoft, to name a few of the biggest companies. They have a "corner' on their stable of "horses."

It's through these individuals that your trades are struck. Think of them as performing two distinct jobs:

1. Being a dealer to buy or sell one's own, or one's company's equities.
2. Serving as a focal point for an orderly market to draw other buyers and sellers to execute trades.

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