stock prices

December 14, 2007 6:00 AM

How are stock prices determined at the exchange?

I'm not talking from a macro point of view, I just mean what are the mechanics of an auction market like the NYSE? If a specialist gets a certain number of orders is there some equation that they use to bump up the price? And obviously most orders are done using a computer system so what sets the price?

posted by amsterdam63 to work & money (9 comments total)

That's not what it is. There is a list of shares being offered at various prices. If the current price is 20, there will be someone who is offering shares at 20.25, someon offering shares at 20.5, someone offering shares at 20.75, and someone offering shares at 37 (who may be smart or may be an idiot).

Equally, there are people offering to buy at 19.75, at 19.5, at 19.25, and at 12.

If that's all there is, there's no activity. But there are also people who say, "Buy at the current price" or "sell at the current price". Suppose that someone says "Buy 10,000 shares at the current price". The first person offering to sell has 4,000 shares at 20.25. The next guy has 5,000 shares at 20.5. The next guy as 30,000 shares at 20.75. So the "buy at current price" guy gets his last thousand shares at 20.75 -- and the price of the stock rises.

The quoted price is the last price anyone paid.
posted by Steven C. Den Beste at 6:19 AM on December 14, 2007 [3 favorites]

The same thing happens when someone says "Sell 10,000 shares at current price". The guy willing to buy at 19.75 was willing to take 6,000 shares. The guy at 19.5 was willing to take 15,000. So 6,000 shares go to the first guy and 4,000 go to the second guy at 19.5, and the stock price falls half a point.

Of course, the market is a lot bigger than that, and millions of shares are changing hands daily, but that's the basic mechanism.
posted by Steven C. Den Beste at 6:21 AM on December 14, 2007

So if I execute an order on say E-trade or some other brokerage for 1,000 shares of a stock that E-trade says is at $5, do they order 1,000 shares and just take the lowest prices they can get? What if the lowest price they can get is less than $5 per share?
posted by amsterdam63 at 6:58 AM on December 14, 2007

SCDB's outline is correct, and certainly the computerized trading systems work exactly that way, just clearing transactions where they can match a buyer willing to buy at a price a seller is willing to sell at. The OP mentioned the specialists, who are integral to NYSE floor trading and play a role when there are imbalances in the system -- too many buyers or too many sellers, for whatever reason. To prevent unwarranted price fluctuation ("maintain an orderly market") the specialist will "make a market" as an individual, buying up excess supply and selling when there is excess demand. (Imbalances may be due simply to time of day or other factors that have nothing to do with intrinsic value.) Obviously they try to make money while they are doing this by looking for very small markups on the shares that pass through their hands, although at times they will operate at a loss if they have not correctly anticipated the market.
posted by beagle at 7:04 AM on December 14, 2007

So if I execute an order on say E-trade or some other brokerage for 1,000 shares of a stock that E-trade says is at $5, do they order 1,000 shares and just take the lowest prices they can get? What if the lowest price they can get is less than $5 per share?

If your order is an order to buy at the market, yes, they'll take the lowest offer out there.

If you were selling, in that situation, you could do a limit order: "sell at $5 or more, but not less than $5"; so your trade would be executed at the highest available bid price, but not less than $5. You can do a limit buy also: "Buy 1000 shares at a price not to exceed $5". And there are further nuances in order specification.
posted by beagle at 7:09 AM on December 14, 2007

So if I execute an order on say E-trade or some other brokerage for 1,000 shares of a stock that E-trade says is at $5, do they order 1,000 shares and just take the lowest prices they can get? What if the lowest price they can get is less than $5 per share?

If you put a limit on your buy order (e.g. "not more than $5"), you become one of those people in the list below the current price, and you wait until market fluctuation brings the price back down to your level -- if it does.

If you don't put such a limit on your order, your transaction happens immediately, and you're the guy who makes the price move.
posted by Steven C. Den Beste at 7:22 AM on December 14, 2007

One of the best ways to understand this is to find a brokerage that lets you do after hours trading and just sit on the "order book" link, continuously refreshing it. At least at Fidelity, you can see the after-hours order book, with two columns, one for "bid" and one for "ask." When someone puts a bid in at a price that's higher than the lowest ask price, the order executes and the current price of the stock changes to match the price the last bit of stock actually traded at. Sometimes you'll notice, for example, that there's an outstanding bid or ask order for 10000 shares and that it forms a floor or ceiling to the price fluctuations because every time the price gets to that level the heavy bidder or asker snaps up all the demand at that price level.

I'm not saying you should do after hours trading; just pointing out that some online brokerages let you see the after hours order book. I'm not aware of any brokerages that let you look at the regular-trading-hours order book.
posted by ikkyu2 at 7:30 AM on December 14, 2007

I am not the OP, but clarification requested (based on above explanations):

If there are two people selling, person (a) selling 10,000 shares at $20; and person (b) selling $10,000 of the same shares at $30 (according to SCDB this is a possible scenario); and if person (a) sells his 10,000 shares at $20, and this is the last trade made: then the share price is $20 dollars.

Now, if person (c) comes in, sees the share price ($20), and wants to buy 10,000 shares, and issues a buy order without a limit, and the only seller is still person (b), he will pay $30 a share instead? Is that correct? And if so, wouldn't this be rather an unpleasant surprise?
posted by londongeezer at 9:35 AM on December 14, 2007

Londongeezer, it would be an unpleasant surprise, but yes, that's how it would happen. That's why it's not advisable to put in a buy order without limit (an order "at the market"), especially when you're placing the order overnight to be executed in the morning. A lot of trading systems will ask you "Are you sure" kind of questions if you place a market order. I learned this the hard way years ago by placing a market buy order on the weekend, then a positive story about the company came out in Monday morning's paper, and the price at the opening was several dollars above the Friday close and my expectation.

As a practical matter, if you're buying or selling widely traded stocks on normal trading days where the market is not in some kind of meltdown, a market order place mid-day will be executed in seconds and the swing from your expectations is likely to be pennies, not $10 a share. But still, it is wisest to always put limits on your orders.
posted by beagle at 9:52 AM on December 14, 2007