Why do People Trade?

14 07 2011

People trade with an objective of profiting from the transaction by buying and holding securities in the case of rising prices and by selling and protecting themselves from price declines in the case of a falling market. Traders have a price and value forecast/view of the security that they believe is correct, and they want to profit from the view.

Transactions are normally driven by two factors:

Information: The purchaser/seller genuinely thinks the prices will go up/down. This understanding is usually backed by some commercial development, news, research, or belief. An asset is undervalued when the ongoing market price is less than the intrinsic worth of the asset and overvalued when the ongoing market price is higher than the intrinsic worth.

Liquidity: Holders of securities know they need to hold securities longer in order to make a reasonable profit but are unable to hold them because they need money urgently for some other reason. Traders keep shuffling between assets in search of superior returns. If they know
one particular security gives them a better opportunity to earn, they might liquidate investments made in another security even if their investment objective in that particular security has not matured. Such transactions are liquidity-driven transactions.

Traders go long on a stock they think will go up in price. Such traders are called bullish on the stock. Traders go short on stocks they think will decline in price. Such traders are called bearish on the stock.

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