The Other Side of a ‘Trade’ in the Equity Market

by Abhishekh Kumar author of  Index Investing

Once I was riding back home in a carpool after my day’s work. The fellow rider when he came to know that I work in a financial valuation firm and have authored books on investments in the equity market thought of seeking my opinion about investing in a particular company. Let's call him Vineet for the time being.

Vineet: It’s great to meet you. What do you think about investing in XYZ stock? Is it the right stock to buy? And is it a good time to do so?

Abhishek: I am not very sure about it. But what makes you think about this XYZ stock?

Vineet: Well, the company has been in the news for quite some time and is doing really good. I did some analysis on the financials of the company and found its fundamentals to be strong. Also, its stock price has been increasing and everyone seems to be buying its share.

Abhishek: So, if you think that XYZ is such a really good stock to buy and since all the information that you shared about this company is in the public domain then all the investors would also know for sure that XYZ is a good stock to buy. And when everyone knows that it is a good stock then no one would like to sell it to you. So, from whom you gonna buy it?

Vineet: Well, millions of shares are traded every day with a buyer and a corresponding seller for every trade. So, for this stock too there must be thousands of sellers.

Abhishek: Agree. There will definitely be many sellers for this stock too. But these sellers would not have the same opinion about XYZ as you are having. While you think that XYZ stock price is going to increase, these sellers would be thinking that XYZ stock price would decrease. Definitely one of you two is going to be right and the other is going to be wrong.

Vineet: True. One of us is going to be wrong.

Abhishek: Now whenever you buy or sell stocks have you considered who is the person on the other side of the trade?

Vineet: I have never thought about it. Probably, he/she may be someone similar to me.

Abhishek: This is where most of the investors get wrong. In today's market, when more than 70 per cent of the trade is carried out by institutional investors such as investment banks, mutual funds, insurance companies, hedge funds and pension funds; the probability of that ‘someone’ being one of these ‘big boys’ on the other side of the trade is very high. Now think for a moment when you are placing a buy order of XYZ stock, Goldman Sachs (and its likes such as Morgan Stanley, Barclays, Citibank) which has offices across the world, has regular meetings with the executives and board members of the corporates and has been in this equity market for over five to six decades; has placed a sell order. And since one of you two is going to be wrong in this trade, the probability of you being wrong is much higher than Goldman Sachs being wrong in their judgement.

My fellow rider thought for some time, thanked me for the conversation and said goodbye when his home had come. He had learnt one important lesson of the equity market that day as he got to know who is on the other side of the trade whenever he gets the impulse to buy or sell stocks.

And this is one lesson which you too should keep in mind whenever you get the urge to trade stocks. The person you buy from or sell to are professionals. They are among the best of the best having a cumulative knowledge and resources of thousands of analysts/fund managers with a trading experience of over five to six decades. Of course, these professionals are not always right but how confident you are that you will be “more right” than these professionals.