How is it decided that the price of a stock (or a currency) has dropped by x amount?
I know about supply and demand, demand goes up, price goes up, supply catches up and price comes down again etc., but with millions of sales going on all the time, I guess it must be some central computer program? As demand goes up it’s programmed to increase the price according to demand? It obviously isn’t a person doing it as they couldn’t keep up! So, if this is the case, what happened pre-computers? The crash in the thirties could not have been the result of a computer program. If it is a program these days, who supplied it and when? Do all exchanges use the same program? If not, how can we be sure that the same action in London and New York will result in the same price shift?
Also, if I want to sell my shares, is there some sort of central bank into which I can sell them? Normally I can only sell something if there’s someone else that wants to buy, but this doesn’t appear to be the case in stocks. If a slide starts, surely no one’s going to buy and risk losing money? But if no one’s buying, how can the price slide? Is it based on what they would pay if they were going to buy? That doesn’t make any sense!
I know that there are lots of questions here, but I would be very grateful for anyone who can help. I’ve looked at all the sites I can find, this thread and this link from that thread. I’ve looked at HowStuffWorks.com and nowhere can I find what I need to know.
Simplification alert, but it’s the only way we’ll get through this…
Basically, stock is worth whatever someone last paid for it. In listings each stock is listed as having two values, the “buy” value and the “sell” value. The “buy” value lists what you can buy the stock for right now. If it says £3.25, then there is someone right now who wants to sell for £3.25. The “sell” value is obviously what you can sell for right now.
There is no central bank for shares. Instead, you buy and sell on the stock exchange via your own bank or stockbroker. You can only sell if someone’s willing to buy, despite what you say about price slides. In most stocks, there’s always someone willing to buy and someone willing to sell. A stock has to become pretty impopular before you simply cannot get rid of stock you own.
About price slides: Slides happen because people buy and sell at successively lower prices. If people didn’t, slides wouldn’t happen. It’s that simple.
You may ask who would be dumb enough to buy at the start of a price slide. Well, when the slide is happening you don’t know if you’re at the beginning of a slide, in the middle of a slide or at the end of a slide. If you buy at the very end of a slide that later reverses itself, you just struck gold. If you buy at the beginning of a slide, you just lost a lot of money.
IANAbroker or anything like that, so I might have it slightly arseways - maybe someone else can correct me if I’m wrong.
But here’s how you can make money from stocks that are on the way down in price - it’s called ‘selling short’:
Imagine that yesterday, shares in Acme Co. Ltd. were trading at £1 each. Acme posted bad market data today, and now the shares are only 50p each. You reckon that by next week, they’ll be down to 25p.
Then you go and find someone - Mr Mug - who reckons that next week they’ll be higher than 25p. He thinks they’ll be 35p each. So you offer Mr Mug (say) 100 shares in Acme at 30p next week, and he agrees, because he wants a bargain. Next week, they’re at 25p each, so you buy 100 of them and sell them to Mr Mug at 30p each, thus pocketing 100 x 5p = £5.00.
An alternative scenario is that the shares only go down to 35p. Mr Mug has got a bargain, and you are out 100 x 5p = £5.00.
Someone always loses, either you or Mr Mug, but you’re both relying on ripping the other one off.
Before computers (and on the New York Stock Exchange even today), stocks was traded by a specialist assigned to it (A specialist handles more than one stock at a time, BTW).
It’s the specialist’s duty to have shares available when people want to buy them, and to buy them up when people want to sell them. Usually, he can match a seller to a buyer. Thus if you want to buy GE stock, your broker gets in contact with someone on the NYSE floor, who goes to the GE specialist and gives him the order. He will have other orders in hand, and he matches one of them to yours. The seller would get slightly less than what you are willing to pay, with the specialist keeping the difference.
If there are more buy orders than sells, the specialist sells stock from his own account. The same thing if people are dumping stock – he’s required to buy up any stock in the companies he covers. On a bad day, he can lose millions, but he makes it back in the long run.
Computers are used with NASDAQ stocks. It’s the same situation, except instead of specialists, certain stock firms “make a market” in a particular stock. They are thus required to buy and sell stock from their own account to make sure the stock is available. They can lose money if a stock falls rapidly, but most of the time, they make a profit on the trading.
Prior to the computerization of NASDAQ, smaller companies traded “Over the Counter,” which made it difficult to match buyers and sellers. It was similar to the current system, but much slower – it could take days to find willing to sell to you.
jjimm, maybe I’m getting out of my depth here, but is that the way that futures work?
Priceguy, thanks for that, but I can ask for some extra details?! My main point was how is the price calculated.
If I say that there are ten people wanting to buy shares in Acme Co. Ltd. Shares are currently worth (say) £10. There are (for argument’s sake) ten poeple who’ve let it be known that they want those shares. Nine people offer £9 per share, one cheapskate person offers £4 per share. Where/ by whom is the price decided? An average of what might be deemed the realistic price is £9. An average of all the offers is £8.50. Midway between them is £7.50 (ish, please forgive my maths!). Who decides the price? Is it just what the seller will accept? If so, how is everything averaged out?
Sorry, just re-read my post and realized I got it back asswards. The “buy” value is what people want to buy for right now, ie the highest price that someone is offering for the stock in question. The “sell” value is the lowest price that someone wants for the stock in question. So if you want to sell, you look at the “buy” value. All clear now?
Moving on. Shares do not have a “worth” as such. It has three prices. Two of those are the “buy” and “sell” values explained above. The third is the price that the stock in question last changed hands for. When you hear that Acme closed at £9.75, that means the last transaction involving Acme shares gained the seller £9.75 per share.
As always, the price is exactly what both buyer and seller accepts. If Acme is currently at £9 and I show up wanting to buy for £35, then I’ll get someone who’ll sell to me, but it doesn’t mean the price of Acme skyrockets (unless people think I’m onto something and follow in my footsteps).
So, the price is decided by what the buyer is willing to pay and the seller is willing to accept.
Once again, sorry for the mistake in my first post.
IANAbroker but I’m a finance student, and I think that if you are willing to pay £35 for a stock worth £9, you will not be able to buy it for £35 unless the price of the market increases to £35. Normally though, If you ask your broker to buy x amount of shares as long as the price is under £35, then he will buy at £9 (usually, people want to buy at the lowest price possible).
However, if you’re weird and desesperatly want to pay a lot more, I think you can trade privatly; my understanding is that anyone that possesses shares can trade them through the stockmarket or privatly - one person selling directly to another one - . There must be some legalities involved but I’m confident enough to say that you could definitly make a deal with someone at a price that is higher or lower than the listed price.
But a broker could put up a crazy price too. Anecdotal example: I own shares in Baltimore Tech (and God I wish I’d sold when I meant to…), and there was one anomalous trade on the LSE that put the price up to £138 or something crazy like that, when the current price was £110. But it was a legitimate trade. I’m sure if a broker puts an anomalous amount for a “buy”, on instruction from a client, you’ll find plenty of people leaping in to sell at the silly price.
Note that when a company is bought out, frequently the price/share offered is well above the current price of the stock. Of course the stock price will eventually rise to that value, if it looks like the deal is going to go thru. Sometimes a deal looks shaky, the price doesn’t rise initially, and then when it suddenly looks like the deal is really going to happen, it jumps then. Conversely, people get burned saying “Hey, it’s at $40 and the offer is $45, I’m buying some of that.” and the deal falls thru when it is revealed that the company has cooked the books and is worth $0.01 now.
Just wanted to add some information about specialists. Unless the rules have changed since I was in school, a specialist is required to make75% of his purchases in a falling market and 75% of his sales in a rising market. In other words the net effect of his own actions are to buffer the prices, stop them from rising or falling too fast. Of course, this frequently results in his buying low and selling high, so he profits in the long run, but in the short run, I imagine it can be scary. Not for the faint of heart.
daytrader here. Here’s a picture showing how it actually looks where buyers meet sellers.
This is called level II and is the actual market in a nasdaq stock as a trader (ie market maker, daytrader, broker) sees it.
In this example, (from the good old days when stocks traded in fractions and CSCO was 110 :), BTAB is selling 100 shares at 110 3/8. If someone ‘takes him out’ (buys directly from him), then PRUS becomes the best offer at 110 7/16. That’s how the price moves. As another example, lets say demand continued and someone took the 100 shares at 7/16 from PRUS and the 1000 shares from PWJC. The offer would then become 1/2 where there is a lot for sale. If another trader wanted shares now he might first try sticking out a bid at 3/8, making himself the best bid. If no one ‘hit’ him, then he might pull his bid and take the offer at 1/2.
So the price moves by trades executed at the current best bid or ask (or sometimes in between). When demand is stronger than supply, buyers start leapfrogging each other on the bid, and sellers get filled or pull their offers and the market in that stock ratchets up. And vice versa. For example, in a ‘slide’ as you say, people keep piling on and undercutting the offer, and buyers disappear from the top of the bid. The market goes down. Lots of traders get ‘short’, meaning that they not only sell all the stock they had, but they ‘oversell’ hoping for a further decline. One way to think of it is if you own stock you have say +100 shares but if you are short you have -100 shares. Now if the market shows signs of stabilizing (eg bargain hunters step up), all those short players are going to get scared (because they lose money when the market goes up) and they start buying to ‘cover’ their position. This then drives the market back up. Until eventually the buying dries up again. This goes on all day long in each individual stock.
All this is a simplified explanation and you can probably find better ones by googling on level-II and trading.
I remember this from Finance, and think it’s correct:
The actual stock “price” is determined by the present value of all the potential future dividends a company will produce. So if a company plans to give back $1 a year for infinity, take the sum of $1 + $0.98 (what a dollar today is worth a year from now, taking into account inflation and other factors) + $0.96 …etc. Add these up and you’ve got the stock price.
If a company shows a profit the future dividends are expected to rise, thus increasing the stock price. If earnings are low the price falls.
No, it’s nothing as mechanical. A stock is worth what people buy and sell it for, nothing more and nothing less. The stock market is governed by three things: expectations, expectations and expectations. If a corporation is expected to make boatloads of money in the future, its stock rises now. That’s also why stock falls when a corporation reveals a lower profit than the market expects; the stock rise caused by its profit has already happened.
If it were as you say, the IT bubble would never have happened. None of those companies made a penny profit.
So everything is kind self-fulfilling, if people, for some reason, believe the markets are going to go down, they almost certainly will.
But, if the stock markets are currently at a low point (obviously they’ve been lower, but they’re lower than they have been in a while) how will they start going up again? I read somewhere that when the total value of the shares reflect the total value of the company’s assets, that is kind of a base level (i.e. the concrete value of assets reflected in the share price). People know that that is a realistic price and things can start climbing again. Is this basically right?
Being “realistic” has nothing to do with stock markets. In recent years there have been cases where, for a time, a parent company’s capitalization was less than the cap. of the stock it held in a subsidiary. E.g., USR and Palm, and Seagate and it’s backup software company.
I have been tracking Home Depot’s quarterly reports lately because I noticed an interesting trend: they were reporting higher than expected earnings and the stock promptly went down. (This streak was finally broken in the most recent report due to poor earnings.) Forget being “realistic”.
ftg, regarding your Home Depot, a lot has to do with future expectations of earnings versus current earnings. Unless a company reports significantly higher than expected earnings with a significantly better outlook, the announcement has already been priced into the stock.
Bob55 was actually a lot more correct than people give him credit for: stock prices are based on discounting future earnings. That certainly isn’t the only factor, but it is the usual starting point. The tech bubble began because analysts hyped stocks on their future potential…and boy, were they wrong (actually, some of them knew what chumps the stocks were, but investment banking fees kept them from speaking the truth).
Future earnings, or lack thereof, are also why some companies can trade below book value. Stockholders are at rock-bottom in liquidation proceedings. When things look really bad, no one wants to be last in line holding an non-performing asset which may or may not pay.
To get back to the OP, price is determined by negotiation between buyers and sellers. Sellers want to get the highest possible price to dispose of their asset; buyers want the lowest possible price to acquire an asset. The role of the market maker is to match the seller and buyer who are in sync at any particular time. Trading Places (which deals with specialists instead of market makers) is surprisingly accurate in portraying how buyers and sellers match up.