I am looking for an article which explains the precise mechanism by which share trades get carried out. In particular, how a share price changes in response to transactions. Any suggestions?
It’s simple supply and demand. Shares are offered for sale, and buyers pick them up. If there’s not much buyer interest, prices decline because they’re not willing to pay a premium. If there’s alot of interest, prices will be driven up, because buyers are willing to pay more. The actual prices quoted on the ticker are just asking prices from those selling being matched with bid prices of those offering to buy.
The Rev
“Shares are offered for sale, and buyers pick them up. If there’s not much buyer interest, prices decline because they’re not willing to pay a premium. If there’s alot of interest, prices will be driven up, because buyers are willing to pay more.”
I know and agree that is the gist of it… but I was looking for the nuts and bolts of it. The price is driven up or down by somehow measuring enthusiasm to buy vs enthusiasm to sell - but how exactly is this measured?
As I understand it, buy orders are matched with sell orders on a first come first serve basis.
So, for example, if you enter a “sell at market” order, your orders won’t get fulfilled until it is your order’s turn.
Or, for example, if you enter an order to sell at a specific price, say $20, then your order won’t get fulfilled until someone else enters an order to buy at $20, and on a first come first serve basis.
“As I understand it, buy orders are matched with sell orders on a first come first serve basis.”
… this is heading in the right direction… but still doesn’t fully answer the question of what the price will be for each trade.
Read the rest of my previous post.
“Read the rest of my previous post.”
If someone says “buy at a price of at most $20” and someone else says “sell at least $19” then a trade can take place that satisfies both requests - but what price would get paid? $19? $20? $19.50?
Somewhere between $19 and $20. I depends on their place in line to get matched.
^^^^ Oh, okay. I see what you are saying. I’m not sure about that.
@OP: Stocks used to be traded on the exchange floor through vocal calls and bids (puts). In some places, they still are, I remember seeing a photograph of the Baghdad Stock Exchange… traders used whiteboards to track trades.
The idea is pretty simple. To purchase shares of stock, you say how many you want and what price you will pay for them. The exchange marks this down. If it already has enough shares to be sold at the price you are offering, it immediately executes the trade. The exchange makes profit on the “spread”, this is the difference between the sale price and the buy price. If I offer to sell 100 shares of XYZ Corp. at $20 and you offer to buy 100 shares of XYZ Corp. at $21, then the exchange executes the trade by collecting $21 per share from you and paying me $20 per share and pocketing the $1 per share difference.
Clayton -
If it already has enough shares to be sold at the price you are offering, it immediately executes the trade."… but still there is ambiguity in this explanation. I would guess that it was too much to ask for someone to explain it all in a posting - surely there must be an article - or failing that, a book, where this will all be explained in detail.
My understanding: Bid v. Ask. Individuals or institutions will make offers to purchase a security for a given price. If a seller is demanding an asking price of the same or smaller amount the transaction is made. The rest is the mechanics of supply and demand, if people are making bids and not getting any hits they have to up their threshold.
"My understanding: Bid v. Ask. Individuals or institutions will make offers to purchase a security for a given price. If a seller is demanding an asking price of the same or smaller amount the transaction is made. "… but at what price?
If a shopkeeper keeps running out of stock of an item, and his supplier can only give him a certain amount each week, then this is a signal that he should raise the price. If a shopkeeper goes for a long period without sales of an item and the item is just clogging up his shelves then this is a signal that he should lower his price. This is all rather approximate and depends on the mindset of the shopkeeper. But in the case of a shares or commodities market this phenomena must surely happen in a more automated and precise way, with frequent tiny adjustments to the price (perhaps a small adjustment after every single trade?) - my question is, how do these adjustments come about exactly?
The essence of trading is that every single share of stock that trades has both a buyer and a seller. That is why it is not 100 percent accurate to say that a stock moves higher because there are more buyers than sellers. For the stock to trade, there must be an equal amount of shares being bought and sold. The real answer is that the stock moves higher because of simple supply and demand.
All you need to do to make a stock go higher is to buy all the stock available for sale at a given price level, then buy more at the next highest level where it Is for sale.
The reason for this is that for each and every stock there is only a limited number of shares for sale at each price level. Your buying and the buying of others will cause the stock to tick higher If you are willing to buy more stock than is for sale at a given price. You and the other buyers will inevitably buy all of the stock for sale at the first price level, and then the remainder of your buy order will be bought at the next highest level (or levels) where stock is for sale.
In other words, if the stock is in demand, the buyers will simply clean out the stock at each consecutive higher price level, causing the stock to trade higher. The opposite holds true if the stock is not in demand.
Let’s look at an example. Suppose you want to buy 10,000 shares of IBM at the market. The stock looks like this:
5,000 shares are for sale at 101
2.000 shares are for sale at 101 1/8
3,000 shares are for sale at 10l 1/4
The problem is that there are only 5,000 shares for sale at the current price. So, you will buy those 5,000 shares at 101 (the current asking price) and then buy the remaining 5,000 shares at the next highest price level (or levels) at which stock Is for sale. You will keep causing the stock to tick higher until you have bought all the stock on your order, in this case all 10,000 shares.
Your buying alone made the stock move up 1/4 point from 101 to 101 1/4 as you cleaned out all the available stock at each price level.
As you can see, IBM did not trade up because there were more buyers than sellers. It went up because the buyers bought stock from sellers at higher levels, because at the moment that was the cheapest price at which there was stock for sale.
“The essence of trading is that…”
Nice. This is more like the level of detail I was after. I still have a question though. You said
"The stock looks like this:
5,000 shares are for sale at 101
2.000 shares are for sale at 101 1/8
3,000 shares are for sale at 10l 1/4"
But how does the buyer get to know that someone is willing to sell 2,000 at 101 1/8? After all, I own some shares and nobody has ever approached me saying “would you be willing to sell your shares at price XXX?” Are there some share owners in the system that are continuously advertising the price at which they would be willing to sell?
Because a seller has advertised on the market that he is will to exchange 2,000 shares of IBM for at least 101 1/8 through an exchange.
Have you expressed your interest at selling those shares in the open market? Privately? If you do not share the information (your willingness to sell X shares at Y price), an interested buyer will never know.
Yes; and when the markets close for the day or weekend, it will re-open for trading with those sellers advertising their willingness to sell their shares. This information alerts the buyers who then use it to purchase those shares of stock (or bonds, or commodity futures).
If you’ve never witnessed it, visiting an exchange can be an amazing experience. If you can, I highly recommend it.
But how does the buyer get to know that someone is willing to sell 2,000 at 101 1/8?
In short, the buyer doesn’t know the price that someone is willing to sell at if the initial stock level is “wiped out.” So, in our example, if 5,000 shares are for sale at 101 and you enter a market order (meaning you are willing to pay whatever price the seller is asking i.e. the ask) for 10,000 shares then you won’t know the fill price for your other 5,000 shares until the sale is executed. Your other 5,000 shares could be filled at 101 1/8, it could be 102, it could be - theoretically - any price. In practice, generally, if it’s a highly liquid stock (i.e. sufficient volume) then the rest of your fill will be reasonably close (within a few points) to the 101 level. That is why many people recommend that you never use a market order as you never know what your exact fill price will be until the trade is executed. If you use a limit order then you set the maximum price which you are willing to pay. Of course, with a limit order, you may never get filled because they are no sellers at that price level that you set.
Are there some share owners in the system that are continuously advertising the price at which they would be willing to sell?
Possibly; only the market makers/specialists* can see the the buying or selling “pressue” (or depth) of that stock. If it’s a liquid stock there are probably many, many orders “in queue” via limit or stop orders. So, yes, they are advertising continously. Overall, though, the market makers are responsible to provide a required amount of liquidity to the stock i.e. they take the other side of trades when there are short-term buy-and-sell-side imbalances. So, even if there is not a private seller of that stock, the market maker may take the other side of the trade of the requesting customer. They get special advantages in terms of information (such as seeing the buying/selling pressue) and trades (such as naked shorting) as a result of providing this liquidity. They use the special advantages to make money by cashing in on the spread, among other things.
- = This is a generalization and varies by exchange; on the NASDAQ, for example, you can obtain level 2 price quotes which give you more information than just the highest bid and lowest ask. Even then the market makers have more information than the general public.
In response to ^^^: That’s why stock exchanges exist… you tell the exchange how much you want to get for your shares (ask) and buyers tell the exchange how much they are willing to pay for your shares (bid). Between the two, the exchange arranges any price-compatible buyers/sellers, executes the exchange and then pockets the spread. As another poster mentioned, the price moves up when buyers buy up all the asks at a certain price point and then the stock price moves up to the next lowest priced asks. The inverse holds for downward price movement.
Clayton -
“How does a buyer know?”
You are familiar with quotes right? If not, your brokerage company that you have your account with offers them along with thousands of other service providers. You obviously would not be contacted personally but your bid or offer would just be filled.
“If someone says “buy at a price of at most $20” and someone else says “sell at least $19” then a trade can take place that satisfies both requests - but what price would get paid? $19? $20? $19.50?”
Depending upon the type of order used to enter these orders, the exact filled price will vary. So let’s just keep it simple and go from there. There is enough volume in most markets that these (2) orders ($20 bid / $19A) would never fill each other.
It all depends upon where the market is trading. Example: If the market is trading $18, then the $20 bid would be filled and the $19 offer would not.
If the market was trading $19, the $20 bid would be filled BUT the $19 offer would only be filled if there was enough $19 bids.
If the market was trading $20, then the $20 bid would only be filled if there was enough $20 offers and $19 offer would be filled.
If the market was trading $21, then the $20 bid would not be filled and the $19 offer would.
Detailed step by step presentation on the equity market including buyers, sellers, broker dealers, and the DTCC. The focus is on FTD (Failed Trades), naked shorts, and other shenanigans in the equity markets. It may not be exactly what you are looking for but is quite informative.