Some people get a thrill trying to pick the right stocks, but the majority are afraid they will pick the wrong ones. But here is a statement: As long as you invest in a market ruled by professionals, you will always buy a fair priced stock. To understand this statement, you have to understand how share prices are set and who affects them.
Who affects share prices?
Certainly not you and me when we are talking larger stocks. Of course we cast our votes with our money, but we at too small to matter in the big market. A lot of people let an investment professional manage their funds instead of trying to do so themselves. This causes that the most successful and thorough professional investors often obtain control over large sums of money and thus more power to determine what the share prices should be.
How share prices are set
When there are many of these intelligent and thorough investors covering the stock market, they are not allowing us normal people to make very stupid investments. On the other hand they are not allowing us to make too smart investments either. If a share you were thinking of buying were too cheap, the professional investors would have bought the shares up until a point where the share price would not make the investment much more attractive than all other shares. In the other case where a share was overpriced given all publicly known information, the professional investors would have sold it until there were no more buyers at a price higher than what would give a fair investment outlook.
The theory behind this is called the efficient market hypothesis and is one of the reasons why passive investing like ETFs are becoming very popular. We believe this theory is somewhat true when investing in larger companies, but as the institutional investors often stay out of small companies, we are cautious when considering investing in these. Do you believe in this theory?