Trading in stocks, much like used shoes, requires a platform for trade execution, clearing, and settlement of funds
Market participants include speculators, investors, and sometimes hedgers
The price discovery process is the constant search for equilibrium amid changing supply, demand, and liquidity
Ultra-complex socio-technical system. That’s a complicated phrase to describe things that are, well, complicated. They have lots of moving people and parts and depend on high levels of technology. Think urban transportation systems. The space program.
One of the biggies often cited: financial markets.
No matter where you are in your financial journey—buy-and-hold 401(k) investor, active trader, or anything in between—the financial markets touch you. So let’s break down the complexity.
One Word: Shoes
Athletic shoes, to be more specific.
In some cultures, showing someone your shoe is considered disrespectful. Here in the United States, however, shoes (or sneakers, really) provide the footing for a new type of trading platform where collector’s items replace traditional stocks in the hunt for price equilibrium.
One such place is StockX, an online trading platform for used footwear—typically collectibles—that “sneakerheads” and other proponents view as being investable assets. Because the company bills itself in media reports and on its website as “a stock market of things,” it seems fitting to use the platform to explain the basics of markets, exchanges, and trading.
One side note, however: rather than a stock market, it might be more appropriate to compare StockX to the commodity market, because shoes might be considered more of a commodity like corn, crude oil, or gold.
Exchanges Are a Secondary Market
When you buy a pair of used shoes from an online exchange such as StockX, the shoe maker (Nike, Adidas, Reebok, etc.) doesn’t get a cut. Once the initial sale was made through a retailer, the manufacturer severed its claim on that pair of shoes.
Likewise, when you buy shares in the stock market, you’re not buying from the company; you’re buying from another trader or investor who happens to be selling. These are shares that were previously issued by the company. When ownership of the shares transfers from seller to buyer on an exchange such as the New York Stock Exchange® (NYSE) or NASDAQ, the company doesn’t receive any proceeds.
So whether you’re buying and selling stocks in the stock market, or sneakers online, you’re dealing in what’s known as a secondary market.
Execution, Clearing, and Settlement
Although the issuer (or shoe manufacturer, in the case of StockX) doesn’t take a cut when a secondary transaction is made, other entities do. In the secondary shoe market, a platform such as StockX does the work of several intermediaries: broker, exchange, and clearing house. A broker essentially acts as a facilitator to buyers and sellers. If you have a brokerage account, you know that that’s where your assets are held—cash, stocks, bonds, and other positions. Before electronic markets became the norm, if you wanted to make a trade, you called your broker, who entered an order into the system. Nowadays, you can simply log in and trade online.
An exchange acts as a central meeting place where bids and offers are matched up (“executed”) in a fair and orderly manner. After a trade is executed, it’s off to clearing and settlement. That’s where the terms of the trade—price, quantity, product, etc. are verified, and the actual transfer is made—the buyer’s money in exchange for the seller’s product.
Price Discovery and Liquidity
What is meant by “fair and orderly?” It’s the process that seeks the highest bid and the lowest offer and ensures that all trades happen at the best possible price. Just as an auction out in farm country can determine how much someone is willing to pay for a herd of a specific breed of cows, the stock market allows buyers and sellers to meet at one place (it used to be a particular buttonwood tree on Wall Street back in the 18th century, or at least that’s the popular myth) and haggle until they agree on a price for a particular stock.
That price is determined partly by supply and demand, and also by how much liquidity is in the market. In the 18th century, that might have meant how many people could find shade under that tree.
Nowadays, this process, called price discovery, happens in fractions of a second, continuously, whenever the market is open.
In more active markets, the increased participation makes it easier to take new positions or exit existing ones without affecting prices too much. In market lingo, such investments have what’s called liquidity. Anything that can be easily bought and sold is known as a “liquid” asset.
Today’s “sneaker exchange” doesn’t have a shady tree to trade beneath, but it does have gymnasiums, convention centers, and what the New York Times calls “a thriving subculture using Instagram, Facebook (FB), and weekend conventions to spot, sell, and trade coveted, sometimes limited edition pairs of basketball shoes.”
Participants: Market Makers, Speculators, Investors
In a traditional exchange, participants vary, and it’s not too different in sneaker trading. Trading in stocks and commodities includes market makers and speculators who try to cash in on short- or medium-term market fluctuations, as well as investors who might be looking for long-term appreciation. These investors might be self-directed retail investors, or they might be so-called “institutional investors” buying and selling on behalf of mutual funds, pensions, and such.
Some players use the market as a risk management tool to “hedge” or try to offset risk. Futures and options are among the products traders and investors use to manage risk, speculate, and attempt to enhance their overall portfolios.
With sneakers, there’s plenty of speculative interest as people try to jump in and out of the market to make a quick buck. Then there are long-term investors who hope they can buy a product that gains value over time. At this point, it’s unclear whether shoe store owners and others involved in the supply chain for sneakers (who could be loosely compared to hedgers and institutional investors) will join in, but if the markets pick up more popularity, it’s entirely possible.
Shoes, and the companies that make, distribute, and sell them—and now the firms that facilitate their resale—make up a small part of the consumer economy, but they’re still part of the ultra-complex socio-technical system that we call the financial market. But hopefully by breaking it down into its individual components, it can all seem a little less complicated.
Like the sound of up to $600 cash?