I thought I’d find an answer to this question with a quick Googling, but apparently it’s not easy to find.
Alternately, I am an extremely weak Googler.
Anyway, can someone tell me exactly how the current price for a stock on an exchange is determined?
Is it computerized based on a straight ahead supply/demand basis? Is it based on volume?
Or, are there people actually setting fixed bids for stocks based on a more intelligent valuation?
Thanks for any responses or relevant links, and apologies in advance if I failed to find some obvious website along the lines of “how stock prices get set.com”
Sellers list how much of a stock they want to sell, and they set a price they’re willing to accept: the “ask price”. Anyone looking to buy can accept an open offer, the sale completes, the price of the sale is recorded, and that’s the official last price of the stock.
Buyers list how much of a stock they want to buy, and they set a price they’re willing to pay: the “bid price”. Anyone looking to sell can accept an open offer, the sale completes, the price of the sale is recorded, and that’s the official last price of the stock.
Everybody is watching what happened on the last sale, and adjusting their expectations of what the stock will be worth on the next sale. They may or may not alter their current ask/bid offers to reflect the last activity.
But the buyers and sellers never actually talk to each other, so how can there be any bargaining?
All I ever see is a current price. If I like the price, I will buy. If I don’t like the price, I will wait for it to go down some more. There must be someone who says “Nobody has bought any of this in the past X minutes, so I’ll now lower the price by Z cents.” Who is he, and how does he decide how long to wait before changing the price?
Or maybe the buyers and sellers do communicate somehow?
“He” is a seller who’s not getting any buyers, or a buyer who’s not getting any sellers.
When you see a “current price” you’re seeing the last transaction to go through. You could attempt to buy at that price and find no-one was actually selling at that price, or with a big enough order, or a slow enough market, no one selling at any price.
Stock prices could move even if any individual seller never changes his prices.
Example:
There are three people (A, B, and C) who own stock in corporation X. A is willing to sell shares for $1, B is willing to sell for $2, and C is willing to sell for $3.
Someone else (D) comes in and wants to buy at the market price. He buys all of A’s stock, but A doesn’t have enough, so he buys some of B’s. The market price is now $2. If E comes in and wants to buy some, more than B has, then the market price will go to $3. A similar example would work for selling.
Of course, in reality, stock owners do change their bid and ask prices as they get more information about the market and the company in question. But a moving market does not require any rapid individual action like someone holding a stopwatch and waiting for orders to stop coming in. I’m not sure, but I believe that the major owners of stocks have a price in mind that they believe the stock is worth, and will adjust their bid and ask prices around that valuation as it changes. Presumably there’s an analyst somewhere that follows a particular stock and recommends what the current price should be.
You can submit two kinds of orders (well more than two actually) – a market order or a limit order. A market order says buy (or sell) for me the quantity desired at the best price available. A limit order says buy (or sell) the quantity desired but only if you can get this price. If a limit order cannot be met immediately it is entered on the books. If it is the current highest bid* it will be the price of the next market order to sell that arrives. If it is the current lowest ask it will become the price for the next market order to buy. If it is not the lowest ask or highest bid, it will remain on the books until it is (or until it is canceled).
*on the NYSE there is a Specialist who keeps the book. The specialist is supposed to supply bid and ask quotes if no one has entered limit orders. The Specialist can and very often does also quote prices between the best limit orders and transact to or from his own inventory.
On the NYSE, there is a specialist who trades the stock. If he can find no buyer (or seller) at the price you want, he can buy or sell stock at that price and hold it until someone comes along to complete the transaction.
On NASDAQ, there are market makers who perform this function. They are usually brokerage firms; the specialist is a single person.
That’s the piece of info that I was missing. There are people (or computer systems) that track these things to coordinate the buyers and sellers, and keep these things “on hold” until there’s a match. (I had thought that if the current price is unacceptable, it just gets rejected.) Thanks.
I’m not sure how good an analogy this is, but betting exchanges I believe work in a similar way. You input in the odds you want, or the odds you’re offering (“buying” or “selling”) and the amount you’re prepared to wager (number of shares), then it’s up to others to accept your offer or not. Or you can just take the best available price. You can see the workings if you choose a market on this website:
No salary. He tries to structure the trades so he makes a little money on each. If someone is buying at $20 and someone is selling at $19, he will buy the stock at $19.50 and sell it at $20 (to give completely unreasonable but illustrative numbers). That’s $50 on a trade of 100 shares and he’ll made dozens of trades a day.
He also is required to buy and sell from his own account. If someone is selling at $20, but the specialist has no buyer at that amount, he will. If he paid $18 for the stock, he’s good, but if he paid $25, he loses.
Because he has to use his own shares (and thus his own money), he has an incentive to match buyers and sellers – in that case, you get some off the top. If you have to buy and sell from your own account, you can run up some big losses (you can make big gains, too, but the nature of the trading usually prevents this). So the specialist is going to try to match buyers and sellers as often as possible.
The specialist also has to abide by the rules of the exchange. If not, he can be replaced by the exchange (this is rare, though, since you make more money if you play by the rules). I remember one story about some commodities traders who sensed the market was going to take a bit hit – which meant they’d lose millions – and were hiding in the men’s room as the exchange was about to open. The exchange told them if they weren’t on the floor when the bell rang, they’d lose their position as specialists. That got them back on the job.
Why do they list the price of the last transaction? Wouldn’t it make more sense to list the lowest “ask price” and the highest “bid price”? Then it would reflect what you would actually pay to buy a share, or get if you sold a share. I suppose they could list different prices for different numbers of shares, or just use the lowest/highest.
Now it’s like going to a store and they list the price at which they last sold an item, even though the current price of the item for sale has changed.
Maybe a more theoretical answer, but I recall from Finance that a stock price is determined by the present value of all of the future dividends a company plans to pay on that stock. Now what people think that is may vary, and some stocks don’t pay dividends.
But say a company plans to pay $1 per share per year on a stock. Well $1 today is worth more than $1 a year from now due to inflation, so maybe it’s only worth 97 cents. The next year is worth 94 cents in today’s currency. So the stock would be worth $1+0.97+0.94…to infinity. I’m not sure what this adds up to, but if I assume $30, then that would be the current price of the stock per share.
Of course if the company is looking at huge profits in the future, the dividends it can pay out per share go up although many companies in reality reinvest these profits into the company or buy up shares, but either way the stock price will reflect this and go up.
It only requires a single number. Thus you can put a transaction on a ticker as GE 10.25 and everyone would know what the sale was*. That’s important to people following the ticker or the stock. Adding the extra number would slow things down a little bit each transaction, which would have a cumulative effect over the course of a trading day.
When stocks were traded by eighths, there was a standard different between the bid and ask, so if you wanted to know the exact bid and ask you’d know they’d be 1/8th above and 1/8th below the ticker price. I would expect it’s no different now: stock expert know what the bid and ask are by looking at the actual selling price.
*100 shares of General Electric @ $10.25
The “Level II” window shows the current order book for stocks. It will show the bids/offers of specialists, market makers, and ECNs. Normally you have to pay for this…but I found it free here:
Though, this isn’t perfect. There is more to the order books than visible on that site.
