The mechanics of stock trading can seem confusing to people who are not used to an auction-type trading environment. Understanding how to enter orders to get the prices you want is also important. For these reasons today we’ll discuss how stocks are traded and what price you will get when you enter a trade.
To understand how stock purchases work, first you must understand an auction-type market. The stock trading floors are filled with hundreds of people all buying and selling shares for their clients and their companies. Add to that thousands of people trading via computer programs. The purpose of this system is to match buyers to sellers. At any given time for an actively traded stock (which is most of the stocks you will have heard of) there will be dozens of people looking to buy or sell shares. They will be offering all sorts of prices for the shares, based loosely on the price the shares traded at recently, current events, the feelings of the buyers and sellers, and other factors.
The people buying shares will have some price they are willing to pay and the sellers some price they are willing to take. There will be some maximum price offered for the shares, called the bid, and some minimum price at which someone is willing to sell the shares, called the ask. The bid price is always a few pennies to a quarter point or so below the ask price. The fewer people buying and selling the shares, the larger the spread between the two prices can be.
When you buy shares, you will pay the current ask price. When you sell shares, you will get the current bid price. This is because, in general, the trader buying or selling the shares for you will buy them from someone at the bid price and then sell them to another person at the ask price.
The price shown on various websites on the internet is usually the price at which the stock last traded. It will usually trade for around the same price the next time, but not always. If people are not that eager to buy, the bid price may be well below the previous sales price and the price will drop before any shares are bought. If people aren’t that eager to sell, the ask price will be far above the lase sales price and the price will move up before shares are traded. There will always be little fluctuations in trading prices, depending on what price people are willing to accept, and sometimes because the price is moving up people will get excited and be willing to pay more for it, but in general it will fluctuate in a given range.
The times when the price changes significantly are when events happen that affect the particular company – like they report earnings – or events that affect the market in general – like a country looks like they are heading into a recession. When this happens, price changes are almost immediate. As soon as you hear the news, so does everyone else. If the news is bad, there will be no one willing to buy the shares unless the price drops significantly. If the news is good, no one will want to sell the shares unless the buyer is welling to pay significantly more than the last sales price. Just like you can’t sell your car for the price it was just before it was in an accident right after the accident, no matter how fast you put it up for sale, you can’t sell a stock for the price it was selling at just before bad news comes out. It drops immediately.
In general, it is sufficient to put orders in a market orders, in which you will buy or sell the shares for the current ask or bid price. Note that if there are a lot of orders to buy at the same time, the orders will be filled in the order in which they were placed, so the price may move up somewhat as the orders are filled and the shares offered at the lower ask prices are purchased, moving the share price up to the next lowest ask price and so on.
If you want to only buy or sell the shares at a certain price and have some control, you can also place a limit order. In a limit order, you set a limit to the price you will pay to buy or sell the shares. For example, if you place an order to buy XYZ stock with a limit of $50, you will only buy shares if the ask price drops to $50 per share or below and you are the first one at that price. Likewise, if you sell shares XYZ shares with a limit of $50, you will only buy shares if the bid price goes to $50 or higher. Note that because the first person to place the order gets his shares first, I usually place limit order sat odd values. For example, I might place a buy order with a limit of $50.05 instead of $50 even since I figure there will be several orders in at $50 per share and I will get the shares first since my price is slightly higher if I place it just above this even dollar value.
Most of the time it is sufficient to place market orders, particularly if the shares trade frequently and there is a lot of volume. If the stock trades thinly, however, or you are not that eager to buy or sell, limit orders can make sense. Just avoid setting a limit on a stock that you have made a good profit on too high. I once set a limit of $22.25 on a stock that had risen from $4 per share to $22 in a few months. The stock never hit $22.25 and I didn’t sell out until it was trading for $2 per share! Sometimes, it just makes sense to sell at the market, or at least place your limit order below the last trade to increase the chances that the shares will sell.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.