Most people are aware that market prices move because of buying and selling, but not many people understand how buying and selling moves market prices. It may be confusing at first glance since every market transaction requires that there always be a buyer and a seller.
Let's take a 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. The next step is recognizing the type of price at which orders are being processed, as that will ultimately move the price.
- Two traders create a transaction at a purchase and sale price, called the bid-ask spread.
- Bid and ask prices drive price movement because if there is a trade, that trade price disappears, and the price moves to the next available one.
- Prices move very quickly because they follow the speed at which transactions are occurring.
The Bid-Ask Spread
Whether it is the stock, forex, futures, or options market, every 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 at which a buyer is posting an order. The offer price is the lowest advertised price at which a seller is posting an order. The difference between these two prices is called the bid-ask spread.
The bid and ask prices always exist because if they match, a trade occurs. Those orders then disappear from the market, leaving the other bids and offers that haven't yet been matched.
There are bids at multiple prices and people bidding different volumes of shares (in the stock market) or contracts (in the futures market) at each of those prices. The same goes for 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 specific prices. All these bids and offers of various sizes and prices 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 decide to put out a bid or offer at any price they desire, but there is no guarantee another trader will transact with that order.
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 following 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 at which someone is selling—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, 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.
When a sell order comes into the market that is bigger than the number of shares available at the current bid, then the bid price will drop because the selling absorbs all those shares at the current bid.
When a buy order comes into the market that is bigger than the number of shares available at the current offer, then the offer price will move up because the buying absorbs all those shares at the current offer.
The Speed of the Market
Transactions may occur at a furious pace. People are bidding 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 bids or offers but are simply transacting among the bids and offers currently available.
When transactions occur at the offer, it is called buy volume, and when transactions occur at the bid, it is called sell volume.
Prices can move quickly or slowly depending on how aggressive the buyers and sellers are. The price can move very quickly if 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.