Understanding Stock Prices
One of the difficult concepts for new and beginning traders to grasp is that stocks do not have a set price. Everyone understands that stock prices change from minute to minute, but they don’t necessarily understand how a stock price changes.
No Stock Store
Part of the problem some people have when trying to understand stock prices is that they try to apply the same model that they are most used to in their regular life, store pricing. Walk into a Target or Safeway store and you will see lots of items that you can purchase, just like you can purchase lots of stocks.
At the store, the price listed is the price per item. At the stock market, the price listed is the price per share.
But, at the store, the price displayed is the price you pay. Offering a lower price isn’t an option, nor is it necessary to offer a higher price in order to get more of an item. Everyone pays the price that is displayed.
Stocks, however do not work this way. They are traded on stock market exchanges like the New York Stock Exchange.
Historic Stock Prices
Most investors get confused by stock quotes because they think that the quote they see is the price of the stock right now. That isn’t true. The quote displayed on a real-time stock ticker is what the price of the stock was BEFORE, not now. In fact, the price displayed is the price the last buyer paid. If you were to try and buy the same stock, you may or many not get the same price.
Bid and Ask
How are stock prices set? How do stock prices change?
To understand how a stock price is determined, we need to understand how a stock’s Bid and Ask work. To explain how bid and ask work, we turn to super-slo-motion.
Imagine that the last trade in XYZ stock took place at $50 per share. That is the price that will display on the ticker, but that is the price that XYZ stock was THEN, not NOW. What is XYZ stock’s price now?
The answer depends on whether you are buying or selling and what kind of order you are using.
If we slow time way down we can see exactly what is happening. Let’s start the stopwatch at 10:00 AM when XYZ stock trades at $50 per share. (While things can move in fractions of a second, we are just going to use whole seconds to make things simple.)
At 00:01 there IS NO PRICE for XYZ stock! How can that be? Because no trade excutes at 00:01, so there is no price. The only price that exists is the old price from 00:00 which was $50.
What does exist at 00:01 is the bid and the ask for XYZ stock.
Until a new bid or a new ask come along, or until another market order is executed, there will not be a new price set for the stock.
So, that is how a stock price is set.