How Stock Prices Are Determined

Understanding how stock prices move is fundamental to investing. It's not magic—it's the collective actions of millions of buyers and sellers expressing their opinions with money. [DEFINITION] Bid Price: The highest price a buyer is willing to pay for a stock. [DEFINITION] Ask Price: The lowest price a seller is willing to accept for a stock. [DEFINITION] Spread: The difference between the bid and ask price. ### The Basics: Supply and Demand Stock prices are determined by one fundamental principle: [KEY] When more people want to buy a stock (demand) than sell it (supply), prices rise. When more want to sell than buy, prices fall. Every trade requires a buyer AND a seller at an agreed price. [EXAMPLE] Apple is trading at $180. Suddenly, Apple announces record iPhone sales. - Buyers flood in, willing to pay $182, $185, $188... - Existing holders don't want to sell at "low" prices - The price climbs until buyers and sellers find a new equilibrium, say $190 ### What Influences Supply and Demand? **Company-Specific Factors:** - Earnings reports (quarterly profits) - New product launches - Management changes - Legal issues or scandals - Dividend announcements **Industry Factors:** - Competitive dynamics - Regulatory changes - Commodity prices (for relevant industries) - Technological disruption **Economic Factors:** - Interest rates (higher rates = stocks less attractive) - Inflation data - Employment reports - GDP growth - Consumer confidence **Market Sentiment:** - Fear and greed cycles - Momentum (prices can keep moving in one direction) - News and social media buzz [TIP] In the short term, prices are often driven by emotion and speculation. In the long term, they tend to reflect actual business performance. This is why patience pays off. ### The Bid-Ask Spread Every stock has two prices at any moment: [EXAMPLE] Apple shows: Bid $179.95 | Ask $180.00 - If you want to buy immediately, you pay $180.00 (ask) - If you want to sell immediately, you receive $179.95 (bid) - The $0.05 spread goes to market makers **Spread implications:** - Liquid stocks (Apple, Microsoft): Tiny spreads ($0.01-$0.05) - Illiquid stocks: Wide spreads (potentially $0.50+) - Wide spreads = hidden trading costs [FORMULA] Spread Cost = (Ask - Bid) ÷ Bid × 100 = percentage cost [EXERCISE] A small-cap stock shows Bid: $10.00 | Ask: $10.50. You buy 100 shares at $10.50 and immediately want to sell. What's your instant loss? |ANSWER| You'd sell at $10.00 (bid), losing $0.50 × 100 = $50 immediately. That's a 5% loss just from the spread—a hidden cost of trading illiquid stocks. ### Price Discovery in Action When major news hits: **Before earnings release:** NVIDIA at $500 **Earnings announced:** Beat expectations by 30% **After-hours trading:** Price gaps to $540 **Next morning open:** Opens at $545 as buyers pour in [WARNING] Stock prices can be irrational in the short term. A company can release excellent earnings and still fall if the results were "less excellent than expected." The market is a voting machine (short-term) but a weighing machine (long-term). [SCENARIO] You watch a stock drop 10% on "bad" earnings. Before buying the "dip," ask: Did the business fundamentals actually change? Or did the stock just reset to a fairer price? Not every drop is a buying opportunity—sometimes the market is correctly repricing a stock.