A Story About How Markets Work

Geoff Cook - CFP, CHAIP

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Once upon a time, a drought comes over the land and the wheat crop fails. Naturally, the price of wheat goes up. Some people cut back and bake less bread while others speculate and buy as much wheat as they can get and hoard it in hopes of higher prices to come.

   The king hears about all the speculation and high prices and promptly sends his soldiers from town to town to proclaim that speculating is now a crime against the state-and that severe punishment is to befall speculators.

   The new law, like oh so many laws against the free market, only compounds the problem. Soon, some towns have no wheat at all-while rumor has it that others still have ample, even excess supplies.

The king keeps raising the penalty for speculation, while the price of wheat, if you can find any, keeps going higher and higher.

   One day, the court jester approaches the king and, in an entertaining sort of way, tells the king of a plan to end the famine-and to emerge as a wise and gracious ruler.

   The next day, the soldiers again ride from town to town, this time to proclaim the end of all laws against speculation-and to suggest that each town prominently post the local price for wheat at its central marketplace.

   The towns take the suggestion and post the prices. At first, the prices are suprisingly high in some towns and supprisingly low in others. During the next few days, the roads become virtual rivers of wheat as speculators rush to take profits where available. By the end of the week, the price of wheat is mostly the same everywhere and everyone has enough to eat.

   The court jester, having a keen sense for his own survival, makes sure all the credit goes directly to the king.

Hedge Fund Market Wizards - How Winning Traders Win
- Jack D Schwager

I came accross the above story while reading a book. I thought it was a great explination of how a market works. Whats interesting is that all markets work basically in the same way. Investment markets are not much different then the markets we visit to barter for goods.

Moral of the story, don't let day to day speculative scenarios or fear influence your decision.

As Warren Buffet says "In the short term the market is a voting machine, in the long term it is a weighing machine.

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