Who decides the price of a stock?

The prices you see scrolling by on the bottom of the screen on CNBC are records of actual trades between a willing buyer and a willing seller. Each trade is recorded, beamed electronically to millions brokerage houses, Web sites and other sources of stock quotes, and becomes a benchmark – the “market price” - for the next trade. In the end, it’s just one big auction. Kind of like eBay, but a lot faster.

It all starts when Bill Buyer in Boise and Sadie Seller in Savannah call up their broker (or go online) and place a trade. Bill says: “I want to buy 100 shares of Global Nanotech.” At roughly the same time, Sadie places an order to sell 100 of her shares.

Most orders (buy and sell) are placed “at the market” – which means “I want to buy or sell now, just get me the best price you can.” All these orders are routed through a series of brokers, dealers, and computers and, in the case of the New York Stock Exchange, end up at a physical trading post, where thousands of other orders are flooding in at the same time. As they come in, these buy and sell orders are matched up, by computers and/or human beings, based on the price of the last trade recorded for that stock (the “market price.”)

An order to buy 1,000 shares may end up being filled with 10 orders to sell 100 each; if the market is moving quickly, the sellers of those 100-share lots may not get exactly the same price. The matching process involves a running list (an “order book”) of buy and sells requests which are paired off as prices match up and the trade is “cleared.”

Things get a little more complicated if you want to add conditions to your trade — like demanding a specific price। Some buyers and sellers will use what’s called a ‘limit order’ — “I won’t sell unless I get $50 a share” – in which case the trade can’t go through unless a buyer is found who is willing to pay that price. Sellers can also place what’s called a “stop loss” order — “If the stock falls below $50 a share, sell it.”

If the price a buyer is willing to pay (the “bid” price) is higher than the price a seller is willing to offer (the “ask” price), there’s a “spread.” In our case, Bill is willing to pay $52 and Sadie is asking for $50. When that happens, the dealer or market maker matching the trades sometimes pockets the difference. If the spread goes the other way — Sadie wants $52 for her shares and Bill is only willing to pay $50 — in theory the trade won’t go through. On the New York Stock Exchange, the people matching trades (called specialists) are supposed to dip into their own pocket, if necessary, to match trades and keep the market moving.

If Sadie wants $52 and she's the only seller, however, and Bill has placed a market order, then $52 becomes the market price and that’s what Bill pays. And if there are a lot more buyers than sellers at that moment, that higher price — the new “market price” — may bring more sellers into the market, providing plenty of orders on both sides at that price, where it will settle for awhile. But if there are more still buyers than sellers at $52, the price will likely go to $55. At some point, the price reaches a point where the number of buyers and sellers are roughly in balance. (The same scenario works on the way down with more sellers than buyers.)

But if trading gets too lopsided — everyone wants to sell and no one wants to buy — the exchange may stop trading for what’s called an “order imbalance,” which is usually caused by a piece of very good or bad news about the stock — or even a rumor being passed around by traders. After everyone’s had a chance to digest the news, trading starts up again at a different price and (usually) things go smoothly again.

Once a trade is made, it’s then recorded and the price is sent around the world as the next “stock quote” (and the number of shares added to the “volume” number for that stock.) Bill and Sadie get confirmation notices showing the price they got for their trade (minus the broker’s commission.) Electronic bits are then moved from Sadie’s brokerage account to Bill’s. (Physical stock certificates – or other pieces of paper representing financial securities — rarely change hands these days.)

The result is a steady stream of millions of shares traded that reflect the price buyers and sellers are getting for their shares. Unless you’re a day trader, the mechanics of each trade — and the small, minute-to-minute price moves that result — don’t much matter. But no one person or group sets the price. We all do.