It's one of those questions that you hear and figure you know the answer to, but take a moment and try to answer it.... why did Google just go from $640.31 to $641.25 in 3 seconds? Has the value of the company and its products changed somehow in that time period? ..... What's making it move higher?
To the question "why do stock prices rise?" most people answer, "because there are more buyers than sellers so the price goes up!" Well this isn't quite right, there are no more buyers than there are sellers, you need one buyer and one seller to make a transaction, so someone just bought Google at $640.75 and someone else sold it exactly that same price.
To completely understand this, you have to grasp the idea that the stock market is an auction system of buyers (bidding) and sellers (asking) for prices.... hence the bid and ask.
To get a better idea, I will use an analogy I recently read in a book. Let's say you put your BMW up for sale at $50,000, someone comes in and offers you $45,000 for it. You now have a market, a buyer and a seller, but no transaction is taking place because nobody has agreed on a price. You bring down the price to $48,000 and the buyer agrees... now a trade has taken place and the "Last" known price on that BMW is $48,000.... this is how "Last" or "Latest Trade" prices are posted on stocks.
Now, let's expand this. You put the BMW for sale at $50,000, and someone else has put a similar one for sale at $51,000 and someone else at $52,200. The same buyer wants to buy at $45,000. BUT now a hedgefund guy wants to buy his top two sales guys BMWs (which are similar... you know, to avoid jealousy)... he looks into the market and sees three are for sale. He doesn't have time to haggle over a silly couple of thousand dollars, he wants the cars NOW! So, he buys the lower priced $50,000 one, but he still needs another, and there are no more for sale at $50k!! Since he wants the same cars and he wants them now he goes to the other seller and buys the other BMW for $51k. Now the "last" price or "latest traded" price on that specific BMW is $51,000. Market prices went up!
Stocks are the same, there are sellers at certain prices, and they only have a certain number of shares to sell. So more buyers don't necessarily bring up prices, but buyers who want the stock NOW do! They buy the lowest priced stock, when there are no more sellers willing to sell at that price there will be sellers willing to sell at higher prices... if the buyers are willing to pay a little more they buy the shares from the higher sellers too and the price of the stock rises!!
The next post will show more of this with Level II quotes....
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