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Know Your Bear Markets

  • Dec 14, 2001
This chapter is from the book

This chapter is from the book

Bear-Proof InvestingBear-Proof Investing

Learn More Buy

This chapter is from the book

This chapter is from the book

Bear-Proof InvestingBear-Proof Investing

Learn More Buy

Market-Liquidity Bear Markets

Market liquidity simply means there are plenty of buyers and sellers. When no one wants to buy a particular stock, you can bet the price will drop dramatically. Every market transaction requires two parties: the buyer and the seller. If one is absent or in short supply, the price will move in the opposite direction.

For example, John wants to sell his XYZ stock and hopes to get $50 per share. No one wants to buy XYZ. His options are to sit tight and hope buyers show up at $50 per share someday or to lower his price for the stock. However, even if he lowers his price, there is no guarantee he will find any buyers for his stock. On the other hand, if John wants to sell his stock for $50 per share, he might find several buyers for XYZ, and they bid the price up to $65 per share.

TIP

The most recent dramatic example of market liquidity occurred on Black Monday in October 1987, when the Dow Jones Industrial Average dropped over 500 points in one day. Sellers flooded the market; however, there were few buyers. The result was a huge drop in the market.

In the first scenario, there was no liquidity because John could not find any buyers for his shares. We assume that we can sell our stocks at any time. When there is a serious bear market, buyers will be hard to find. Stocks are not like bonds or certificates of deposit that have a fixed, and in the case of most CDs guaranteed, principle. Stocks are only worth what someone is willing to pay for them.

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