“Let us not negotiate out of fear, but let us not fear to negotiate….”
Even though that quote by John F. Kennedy had a very different context, it is surprisingly applicable to life in the market. Prices in the world of trading are similar to prices that people pay for items in the store. Let’s suppose that you, the buyer, go into an electronics store to buy a camera. The store in this example is the seller. Generally most buyers that go into a retail store believe that the price on the sticker is fixed i.e. the selling price is the price they have to pay, and once they pay it, it becomes the ‘market’ price. When the item is popular, it generally doesn’t go on sale (like most Apple products), and if it is unpopular it is highly discounted. What most people don’t realize, however, is that what they want to buy the item at is one possible price, and what the retailer is selling it at is also another possible price. The final price, the one you actually pay at the register, is a reflection on what both the buyer and the seller ultimately agree upon. To think like a great trader, you almost always are inclined to negotiate, even at retail, because great traders realize that there is always a price they can pay that may or may not be better than the price on the sticker.
Going the distance
The difference between what a buyer is willing to pay for something and what a seller is willing to sell at is referred to as the spread. Most beginner traders or investors look at the last price as an indicator of what something is worth, and while not incorrect, what great traders pay attention to is the distance between the prices of buyers and sellers – the spread. After all, once you buy something with expressed intention of selling it, you want to be able to be sure that you are going to get a good price for it. Spreads between prices are very valuable in establishing how efficient the market is for a particular stock.
Markets that function well are those that can efficiently determine what something is worth. The more participants there are in a given stock, the better the chance that the “market price” is close to what the stock is actually worth (or at least that’s what the theory says should happen). A market for a given stock with lots of participants is said to be highly liquid – meaning that one can easily purchase or sell that stock should they want/have to. For example, cash is considered a very liquid asset because you can readily spend it (technically it’s very easily transferred). A collection of antique dishware, though valuable, is not so readily convertible into cash.