It almost seems so obvious that businesses should know who their customers are. In the real world, many small businesses can get to know their customers’ buying habits and taste, and they even might get to be on a first name basis with them. As companies get bigger, they don’t see customers per se, they see statistics about their customers, such as what gender they are, where they live, what kinds of products are they buying and at what times. Big or small, it pays to know who your customers are and what they want so that, as a great trader (read: middle man or middle woman), you can more effectively exchange your goods for your customer’s cash. An interesting ‘quirk’ of the stock market is that your customer can also be your competitor.

Even though knowing exactly who your customer is just as crucial for the do-it-yourself investor as it is for any other business, the reality of online trading makes this infinitely more challenging. Your “customers” are just numbers and letters on a screen. You have no idea on who they are or what their buying habits are. All you really see are share prices either rising or falling, and from there you can infer that there is either increasing interest in a stock or decreasing interest at any particular price on any given day. And as unsatisfying as that is, millions of people around the world base their stock trading decisions simply on what they are inferring from movements in stock prices. What separates the great traders from the rest of the herd is the understanding what their customers are looking for.

Who’s on the field?

So as a stock trader or investor, who are your potential customers in the stock market? For starters, other retail investors/traders – these are the smallest fish in the pond. Next, there are the institutional investors/traders representing an even broader category of skill levels and motives. On the institutional side of things you have anyone from small mutual funds and hedge funds to large or even behemoth players such as mega-mutual funds or endowment funds (such as university investment funds), pension funds (such as the Teacher’s Pension Plan) or sovereign wealth funds (funds managing an entire nation’s wealth). And then there are the seldom heard of market makers, the participants who “make the market” by being ready to buy or sell shares at a moment’s notice. It is important to know who your customer is probably going to be before you decide to buy a stock online.

The diversity of possible customers also means there are also different buying habits and different reasons for buying. For example, large mutual funds have lots of activities to try and coordinate and are complex to run. Recall that a mutual fund is a pooled amount of money usually managed by a team of investment professionals. Generally, each mutual fund agrees to follow specific rules that dictate how, when and where the fund can invest. This is known as their mandate. In one of our videos with Danielle Park of Juggling Dynamite, she gives viewers some great insight into why knowing the mandate of a fund is so important. Some mutual funds are also required to be “fully invested”, meaning they cannot have more than a certain portion of the fund in cash – it has to always have a certain percentage in stocks or bonds. This means that no matter the weather, some mutual funds are out buying stocks, even if those stocks are going down in value. When’s the last time walking off a cliff made sense, simply because you had to keep walking? In the world of mutual funds, some of them have to keep walking (read: investing) cliff or not.

One of the things experienced traders understand that beginner traders often get wrong is how to navigate around the other players on the field. For example, some mutual funds will not look at stocks underneath $5 because stocks under this arbitrary number carry increasingly higher amounts of risk (or so the story goes). Alternatively, if a mutual fund tried to purchase a significant amount of a “penny stock”, they could actually artificially drive up the price, and just like everyone else, if they needed to sell there would not be a customer large enough to take shares off their hands when the time came to exit.

Deal or no deal?

Many retail investors/traders, however, are lured into looking at very low priced stocks (aka “penny stocks”) such as those that trade well under the $5 mark. But, as we noted above, many of the really big players aren’t going to be able to purchase them, so if you buy a “penny stock” who can you expect to sell it to? Well, your options are limited mostly to other retail investors, or some very speculative institutional buyers/funds and market makers. Translation: with fewer people in the market for these types of stocks, there are fewer likely customers and fewer likely customers means less reliable pricing of what the company is actually worth. Remember that the greater the number of participants in the market the more likely there will be somebody to buy shares from you should you choose to sell.

The reason stocks trade where they do is because of belief or perception of value and perception of risks. If the belief of the majority is that more can go wrong than can go right, that pessimism shows up in as low or declining stock price. On the other hand, if there is a belief that a company can do no wrong, those expectations show up as a rising stock price. Typically companies go through cycles where investors shift between one extreme or the other, however occasionally you will find a stock that has a long stretch of investor optimism or pessimism – as signaled by either rising or falling prices respectively.

So what’s the bottom line?

Savvy investors and great traders understand that when buying and selling stocks online, they need to have another party on the other end of that transaction in order to realize a profit. They understand that if there are no customers, for whatever reason, they (the holder of the stock) might be left “holding the bag.” For that reason, great traders take the time to learn their market, who their customers are, what they are looking for and what keeps them away. When you start treating trading or investing like a business person, the time to ante up or the time to fold and walk away will be much clearer.