Imagine you have won a pair of limited-edition Nike sneakers in a lucky draw but want to sell it on Carousell. Since you are unaware of its real value, you set the price at $80. Someone who works at a Nike Shop who knows that it is worth at least $300 in the market, would surely offer you $80—albeit quietly—to try to profit from this difference in knowledge. But what if there is another buyer who is a die-hard Nike fan? As he also perceives the shoe as being very valuable, he will probably have to offer a higher amount so that you will consider his offer. A bidding war between the two informed buyers is likely to ensue and all it would take is just two informed buyers to drive the price of the shoe to a fair market value.
Now, imagine multiplying this effect to consider the millions of buyers and sellers. This is what goes on every day in the financial markets.
Because markets usually do a good job incorporating all publicly known information into prices, we would be better off investing as if current prices are correct instead of trying to guess their future direction. This allows us to focus on our overall plans, which is a far more reliable way to get us closer to our financial goals than trying to predict how the stock markets will react to headline news.
This series is adapted from the book, 27 Principles Every Investor Should Know, written by Steven J. Atkinson. Read the rest of the principles:
- Investing Principle #4: Investing Is Hard – Get Help From A Trusted Advisor
- Investing Principle #5: Know the Difference between Advisers and Salespeople
- Investing Principle #6: Put Science and Academic Research on Your Side
- Investing Principle #7: Don’t Try To Pick Individual Stocks
- Investing Principle #8 Don’t Try to Predict Markets
Author: MoneyOwl’s Solutions Team