Some investors are puzzled about how share prices are set on the stock markets. Part of the problem is that most of the transactions we do on a regular basis are fixed price.
For example, if you stop for milk and bread at the grocery store, the price is set by the store. Most consumers, at least in the U.S., don't bargain for a lower price than what is on the price tag.
Curiously, we think nothing for bargaining for a car or house. Most of us know the price can be negotiated in many cases.
In many ways, stock share prices are arrived at in the same manner: through an open auction where buyers can offer a price and sellers can accept it or not.
Once a stock moves out of the IPO stage and into the open market, there are a number of factors that go into setting the price.
For example, Amalgamated Kumquats closes on Tuesday at 25½; what will it open at on Wednesday morning? The answer is: who knows. Most likely, it will open somewhere around 25½, but any number of things might cause it to open higher or lower. Before the market opens on Wednesday:
- Civil war in Elbonia, the prime producer of Kumquats
- President of Amalgamated Kumquats arrested for looting the company
- FDA says Kumquats cure baldness
- Huge oil reserves discovered on Amalgamated property
All of these circumstances and many others could influence the price up or down. Silliness aside, the most likely reason the price would change involves something like the release of earnings after the market closed or some other economic or market factors that may change the way investors value the stock.
In the end, it remains a question of what a buyer is willing to pay and a seller is willing to take.
The swirl of market, political and industry news influences whether there are more buyers or sellers for a particular stock in the market at any one time.
Every day the market opens, it's a clean slate. Investors must meet no set prices. Stocks that the day before were flying high may not get off the ground today. The ugly duckling turns into a cash cow (how's that for mixing metaphors).
If the owner of the shares needs or wants to sell them, she will have a price that is acceptable to her. She can put out an offer to sell the shares at her price.
If another investor believes that is a good price for the stock, he will offer to buy the shares. When the willing seller and willing buyer agree on the price, a sale occurs.
Thanks to the electronic markets, this trans action may happen in the blink of an eye.
However, if the seller is desperate to sell, she may agree to a price below what she wants. When investors get nervous about a stock or the trend of the stock market, they begin to sell.
When there are more sellers than buyers, investors must keep lowering the price until a buyer agrees. As long as the imbalance between sellers and buyers exists, the share price will continue to fall.
When the market is going the other way and buyers outnumber sellers, the buyers must keep raising the price per share to attract sellers. As you can see, share prices must rise in the scenario.
The point is a share of stock is worth what someone else is willing to pay for it. That is the heart of investing. A stock may be a good buy at $35 per share and a terrible buy at $50 per share to one investor, however another investor may not think twice about paying $50 per share. Which is the right price? Often only time will tell. Many years ago, some investors thought $10 per share was too much for Microsoft and refused to buy it. Too bad for them.
Successful investors decide what a fair price for a particular stock is and that's where they buy. They don't let market hysteria goad them into overpaying. Likewise, if nothing has fundamentally changed with the company, but the stock is dropping along with the market, successful investors will sit tight and not be frightened off a good price.
As you develop you investing skills, you will learn strategies and techniques to help you establish a fair price for stocks and either get that price or find another stock to buy that meets you investing criteria.