Stock prices are set by what’s known as the secondary market, which is the technical term for investors trading shares among themselves. This is opposed to the primary market, when a company sells shares of stock directly to investors. A stock’s price is set by supply and demand in a secondary market. So when more investors want shares of stock, and fewer are available, prices go up. But when less investors want to buy shares, and there are more shares than demand, prices fall. Let’s take a deeper look at how it works.
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What Is Share Price?
A stock’s price is known as its “share price.” It’s the amount of money investors pay to buy a single share of this stock. Though a share price can vary depending on different factors.
A stock’s share price refers to historic data. It’s the last price at which a transaction took place. This makes it slightly misleading, since share price isn’t exactly the price at which future transactions will take place. The more centralized the market, and the more liquid the stock, the closer the share price will reflect future trading prices.
For example, say that the last transaction for ABC Corp. stock was an investor offering to sell 100 shares for $15 per share and another investor accepting that offer. That makes $15 the stock’s current share price because it reflects the most current data. The last time ABC Corp. stock changed hands, it did so at $15 per share.
Because share price is backwards-looking, it is no guarantee of what the price will be for the stock’s next transaction. Instead, that’s set by what’s known as the bid and the ask.
What Determines Share Price
Share price is ultimately determined by supply and demand in the marketplace. The more shares in circulation there are relative to demand for this stock, the lower its price will fall. The more demand there is relative to shares in circulation, the higher its price will climb.
This is reflected in two types of share prices:
Bid price. For any given asset, including stocks, the bid price is the highest price that a buyer in the market will currently pay for a number of shares. This represents overall demand in the market. The more people who want to buy the stock, the higher the bid price will climb as buyers literally try to outbid each other trying to find a seller.
Ask price. This is the lowest price that a seller in the market will currently accept for a number of shares. This price represents supply in the market. The more plentiful shares are, the lower the ask price will fall as sellers ask for less and less to find buyers.
Ordinarily, the bid price is lower than the ask price at any given time. The gap between these two numbers is known as the bid-ask spread. When the bid-ask spread is wide the market is slow, or “illiquid.” Buyers and sellers are having difficulty connecting and agreeing on a fair price. When this spread is narrow it means that the market is highly liquid. Buyers and sellers are finding each other and frequently settling on a fair price.
Example of How a Bid-Ask Spread Determines Stock Price
The bid-ask spread sets the price at which a sell or buy order would take place, respectively.
When you place an order to buy shares of stock, you do so at the ask price. To buy this stock you need to pay what sellers are asking. When you place an order to sell shares of stock, you do so at the current buy price. To sell this stock you need to meet the buyer’s price.
For example, say ABC Corp. has the following prices:
- Share price $100. The most recent transaction for this stock was for $100 per share
- Bid price – $99 x 100. Buyers currently are offering $99 per share to buy 100 shares of this stock
- Ask price – $101 x 100. Sellers currently are asking $101 per share to sell 100 shares of this stock
Now, say you place an order to buy 100 shares of this stock. By offering to buy shares of stock, you’re agreeing to meet the sellers’ current asking price. You pay $10,100 ($101 per share x 100 shares) for this transaction. The share price of ABC Corp. ticks up to $101, because that’s the most recent transaction price.
By contrast, say you place an order to sell your 100 shares. Now, by offering to sell, you’re agreeing to meet the buyers’ current price. You receive $9,900 ($99 per share x 100 shares) for this transaction. The share price of ABC Corp. ticks down to $99 because that’s the most recent transaction price.
In reality the bid-ask spread is much narrower than this for most mainstream stocks. For example, in December 2022, Amazon (AMZN) had a spread of $0.01. So it’s rare for anyone except professional traders to significantly notice the price difference between the share price and the actual price of their transaction. However, if your brokerage processes a buy/sell order slowly, or if the asset is illiquid, you can sometimes notice a significant price difference between share price and the actual transaction price.
And, over time, this process determines a stock’s share price. The more demand there is for the asset, and the more scarce it is, the more often investors will place buy orders at the higher ask price. This will iterate the share price up, pushing up the bid and ask prices as well. The less demand there is for this asset, and the more shares are in circulation, the more often investors will place sell orders at the lower bid price. This will iterate the share price down, pushing down the bid and ask prices as well.
A company’s share price is the price that it most recently traded for. Its future share price is determined by supply and demand, and set by the bid-ask spread.
Investing Tips for Beginners
- A financial advisor can walk you through smart investment strategies for your financial plan. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- When thinking about how much money you’ll make off of your investments, take into account capital gains taxes. SmartAsset’s capital gains tax calculator can help you figure out how taxes will impact the money you make from selling stocks.
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