How Market Prices Move Through Buying and Selling
How Buying and Selling Causes Price Changes
Most people are aware that market prices move because of buying and selling, but not many people actually understand how buying and selling moves market prices. It may be a bit confusing at first glance, since every market transaction requires that there always be a buyer and a seller.
Here, we will look at how market prices move. First, it's important to understand that there are always two prices in a market: a "bid" price and an "ask" price.
Then next step is recognizing at which of these prices orders are being processed at, as that will ultimately move the price.
The Bid-Ask Spread
Every market, whether it is the stock, forex, futures, or options market has two prices, a bid price and an ask price. The ask price is also referred to as the "offer" price.
The bid price is the highest publicized price a buyer is posting an order to buy at. The offer price is the lowest advertised price a seller is posting an order to sell at. The difference between these two price is called the bid-ask spread. The bid and ask prices always exist, because if the bid and ask are the same a trade occurs. Those orders then disappear from the market leaving the other bids and offers that haven't been matched yet.
There are bids at multiple prices, and people bidding different amounts of shares (in the stock market, or contracts in the futures market) at each of those prices.
The same goes for the offers. For most actively traded stocks there is another bid slightly below the current one. For each offer, there is another offer at a slightly higher price. This is because different people only want to buy or sell at certain prices. All these bid and offers of various size and price are part of the market's order book.
At any given time a trader can choose to buy at the ask price, or sell to the bid price. This will create an instant transaction. The trader may also choose to put out a bid or offer at any price they desire, but there is no guarantee another trader will transact with that order.
Buying and Selling Volume at the Ask or Bid
Assume someone is selling 200 shares at 90.22. If someone buys those 200 shares at 90.22 a transaction occurs and those 200 shares are no longer available. The next offer may be to sell 100 shares at 90.24. If someone buys those 100 shares, or the seller cancels their order, then that order disappears and the offer moves to the next available price someone is selling at, let's say 90.25. The buying was great enough that it removed all the shares available up to 90.95. That is how prices move.
The same thing happens on the bid. If someone sells 200 shares to a person willing to buy 200 shares at 90.21, then the bid at 90.21 disappears. If the next bid is for 300 shares at 90.20, and someone sells 300 shares (or more) at 90.20, then that bid will disappear and the bid below it will be the new highest bid.
Transactions may occur at a furious pace. People are biding and offering at different prices, in different quantities, and they can cancel or change those orders at any time causing the bid and ask to change.
Other traders aren't posting bid or offers, but are rather simply transacting at the bids and offers currently available. When transactions occur at the offer, this is called buy volume, and when transactions occur at the bid this is called sell volume.
When a sell order comes into the market that is bigger than the number shares available at the current bid, then the bid price will drop, because all those shares at the current bid are absorbed by the selling. When a buy order comes into the market that is bigger than the number of shares available at the current offer, then offer price will move up, because all those shares at the current offer are absorbed by the buying.
Price can move quickly or slowly depending on how aggressive the buyers and sellers are. The price can move very quickly is someone puts out a big market buy/sell order.
A market order buys or sells every share, no matter the price, until the order is filled. Such orders may remove all nearby bids or offers, causing the price to change drastically and instantly. Other times the price moves slowly, because there are few transactions, or there are so many shares available at each bid or offer that it is very hard to move the price even with lots of transactions going through.
Updated by Cory Mitchell, CMT