How are stock prices actually set?

We may take it for granted that it’s all about ‘demand and supply’ which determines stock prices. Then I asked myself a few more questions like, “How does that actually work?” – I realised that I didn’t really know. I mean, who sets the price? How is it set? Does the organisation which the share represents set the price? These are natural questions to ask or think about. If it’s the stockmarket that sets price – how do they do that? So I went searching and came up with some links (below) – and information.

In summary the stockmarket is what determines the price. But how they do that is most interesting and gives some ideas about why trading at the open of the markets is rather risky.  This is not about Forex markets.

In essence I’ve extracted the following basic points:

1. There is almost total computerisation of orders and prices. We can’t expect a folks in some back room to be dealing with hundreds of millions of these things.

2. Computer programmes determine the price by weighing up demand and supply (along with other considerations).

3. There is an ‘auction’ approach happening in the above. I don’t think I need to fathom the depths of that.

What does all that mean in practice?

Overnight orders have a significant impact for the opening of the markets. This is why it could be risky to place orders near the opening of the markets, if one is spreadbetting. Strange and unexpected things could happen. If one is playing an ER snipe, then setting a stop or limit order may well miss the mark on opening of the markets. That’s why it’s important to get in at least the day before the ER and set some reasonable stop-losses.

Stop-losses are not fool-proof. They depend on computers finding the right spot and there can be seconds of delay in all that leading to what is broadly referred to as slippage. The other day my stop-losses were missed by 200 points as one of the markets plunged. That’s the risk that has to be factored in as well. Guaranteed stops prevent slippage but on equities on some platforms they lead to very large stop-losses (around 10-15% of the points value on the instrument).

The above may not mean as much if one is trading directly in the markets and one has Direct Market Access. But that’s a different ball game altogether.

This is – as usual – not a tutorial, as this site is not meant to do formal tutorials and teachings (see our FAQ). It is expected that all good traders are self-driven to improve their knowledge. If you wish to learn more then Google is your friend.

Key links (for starters)

1. How NYSE determines prices.

2. How NASDAQ does it.

3. Demand and supply (Investopedia).

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