What Actually Causes a Stock’s Price to Change
Supply and demand.
That’s what everyone has told us growing up. If the demand for a stock goes up, the price will go up, right? That is pretty true, but it’s not like someone at the New York Stock Exchange is shouting, “More people want $TSLA! Raise the price to $350!” No overseeing body is setting the price like a grocery store does with their produce. In general, as the demand goes up, so does the price, but to what value? And how is it determined?
Long story short, the buyers and sellers agree on a price that someone is comfortable selling and someone else is comfortable buying. When lots of people want to buy a stock, the people selling it attempt to raise the price in order to make the most money; alternatively, when lots of people want to sell, they often have to lower what they are asking for in order to entice buyers to pick their shares to be sold. But how does this transaction happen?
Sellers will put in limit orders with their broker to say what price they want to sell the stock at (the ASK price) and buyers will do the same for what price they want to purchase shares at (the BID price). This is called the stock’s Level 2. The difference between these two values is called the spread.
If you want to buy the stock at market value, you may not be buying at the price you see on your iPhone Stocks app. When you tell your broker to make a market order, you will generally buy at the ask price and sell at the bid price.
So, if there are two values, what determines the singular price you see on Yahoo Finance?
It’s the last price at which the stock exchanged hands!
Let’s take a look at Google ($GOOG) on 3 May 2017. Below is a snapshot of the company’s chart where each candle represents a different day.
Below the chart is the level II. Highlighted in white is the value that you see when you simply look up a stock’s current price. In green are the bid prices and number of shares in the hundreds that people are willing to purchase (BS). In red are the ask prices and size (also in hundreds under the AS column).
In this example, if you were to buy the stock and immediately sell it at the market price, you would be buying at $923.62 per share and selling at $923.19 per share. An immediate loss of $0.43 per share! But we still haven’t answered how the stock travelled all the way to $923.19. Well, let’s say that you decide $923.62 is a fair price for a share of Google. You put in a market order or maybe even a limit order above $923.62 (such as – buy if the value is at or below $924.00). As soon as your order fills, you can watch the price (in white) change to $923.64 since that’s the last price an deal was struck at!
Now, say the other 99ish shares were sold to similarly minded people wanting to buy at $923.64. The stock is now out of sellers at $923.64 and the next price someone is willing to sell their shares at is $924.01. So if people want to keep purchasing it, they’ll have to buy it over $924. As soon as those 100 shares are sold we move to the next price down the list, then the next, then the next. This keeps happening so long as there are enough buyers (think demand) to continue buying the shares at higher and higher prices.
These charts are just a snapshot. New offers are constantly added at different prices and different sizes which may keep a stock’s price from rising even if demand grows (for example, if everyone who owns shares decides $923.64 is a good price to sell at then even a large number of buyers may not overcome the number of sellers).
Let’s take a look at what happens a short while later after buyers pushed the price up just a little.
The price has made it all the way up to $924.11! Now, new buyers are putting in offers at $924.01 and sellers are offering to sell at $924.16. So what will happen next is anyone’s guess. Are the sellers going to go down to meet the buyers’ lower prices or are the buyers going to decide that $926.16 is a good price?
It’s by people like you and me reaching an agreement!
All of this price action happens behind the curtains for just about every investor and knowledge of it won’t help you much when you are putting money into hedge funds and mutual funds for your retirement. Unless you take up trading, you really don’t need to concern yourself with the level II of a stock, but it’s always important to keep learning!
If you have any questions or something you can elaborate on more for other readers, please share in the comments!
