Last Traded Price

People have very weird perceptions about price. They even think how can the price change every second. Here is a small story inspired by TV thriller Prison Break which explains you what is Price ?

A prisoner comes to prison with diamonds worth 100 M$ hidden inside his stomach. He takes all of these out in the prison, puking or shitting diamonds everyday. He had 100 pieces of diamonds, each worth a million dollar. Now, he was bailed out of the prison, he could not take those diamonds outside, so he sold it to all the fellow prisoners.
Since he needed money urgently he sold diamonds for 200k each, and took money from their relatives bank accounts after going outside. This is what is called an IPO or Intial Public Offering. Each diamond is worth a million $. This is called "Valuation".

Michael Scofield also found this discount incredible. He consulted his brother and decided to take a loan and buy as many diamonds. He also thought he will break the prison in 4-5 days and in just 5 days, he will get 500% return on his investment by selling diamonds for a million dollar each. He will sell diamonds for million each, return back the loan, and live happily with rest.

Now prisoners all together applied for 500 diamonds, all prisoners were allotted only one-fifth of what they applied. They all had diamonds worth a million by paying just 200k for those, and they are going to get out of the prison and sell it and die rich.

Michael Scofield who applied for 100 diamonds, got just 20, he took at 4 m$ loan, but since he was a prisoner, his credit history was pretty fucked up , so most of the banks refused him loans.
But some WallStreet's, high-risk-high-return bank lend him 4m$ at an interest rate of 5% per day ( Prisoners really have fucked up credit ratings). Scofield being an engineer calculated
he took 4m$ in loan, to buy 20 diamonds, if he takes 4 days to get of prison, interest payment will be another 80k$, still it is a neat investment. He will make 20 million by selling diamonds, and still it is a neat profit.

Now Scofield prison break failed, he could not get out after 4 days. The bank, asked him for interest payments. So he had no other choice other than selling his 2 diamonds at 400k to fellow prisoners who did not get any diamond initially and give banks the interest and pay back the loan by selling rest of the diamonds and still have neat profit. He quoted 400k as the price to sell 2 diamonds. Last traded price of diamond is 40k. This is effectively the market listed price after the IPO.

Now his prison break plan again failed after another 4 days, so he had to sell 2 more diamonds, but this time no other prisoner had 400k to pay. So he lowers down his price, to 200k and decided to sell 4 diamonds. Last trade price is 200k now.

His prison break plan again fails after 4 days. Now nobody has 200k to pay for diamonds. So he quoted his price as 100k and offers to sell 8 diamonds. Now, IPO which opened at double the offer price has slipped to half the offer price. Last trade price is now 100k. Now if you look at the the price, all prisoners have lost half of their money.

Now, everybody realizes that Scofield, is the most intelligent person in this whole prison. Why is he selling his diamonds and half the price ? People start speculating that diamonds might not be real, and people start panic selling it for 50k. About 50 prisoners (who do not even know about the rumour) realized that, they put in 200k for the diamond, now it is 50k. Thats a loss of 150k. They also think that diamonds might go down even more, because price is going down every 4 days. So to cut down the losses they also sell their diamonds for 50k.

Obviously for all 50 sellers there were 50 buyers too. Scofield escaped from the prison he sold rest of his diamonds for Million dollar each. People suddenly get to know that Scofield actually sold them for million dollar. So, now the price of diamonds start rising inside the prison next day people started offering 100k for diamonds, some people who purchased at 50k and did not know about the Scofield news, sold it for 100k and 200k, and now people quoting 750k, but none of them got any diamonds.

So, the idea of last trade price, and marking your portfolio to it , and think about losses is wrong. If you are an individual, you do not need to mark to market your loss/profits. If you know the value of your stock/asset, you should not get worried when somebody starts to sell it for 50% down. You should firmly believe in your stock. Because it is impossible to predict when will somebody start selling the stock that you own for 50% lesser price. So if you know that valuations of the daimonds were a million dollar, you should be more than happy to buy it for 100k and should not worry when the price reaches 50k. A that point you should be thinking to buy more. But remember that, somethings might happen which might change that million dollar valuation to a smaller number.

All Equity research guys will talk about valuations. So the valuations for diamonds is a million dollar. But last traded price fluctuated all the way down to 50k. If you think you made a loss because somebody else is selling the stock that you own at a much cheaper price, it is wrong.

Learning about valuations is nice, but to win in the markets, you must also be able to predict when that somebody will come to sell the stock at 50% less, so that you can buy it at that time.