Publicly traded stocks change price based on supply and demand. Understanding supply and demand dynamics helps you predict the price moves and profit from short- as well as long-term trends in stocks. Closing imbalances between supply and demand can be an important indicator of a price's future price behavior.
In most stock exchanges, orders to buy or to sell a stock are submitted to a floor specialist. The job of the specialist is to speed up the trading activity by matching buyers and sellers. If the most a buyer is willing to pay for a stock is less than the current trading price, or a seller's lowest acceptable price is above the value the at which stock is currently trading, these orders will be entered into a cue. In an actively traded stock, there is a large quantity of buy and sell orders waiting for execution at almost any given point during the day.
Bid and Ask
The buy and sell orders waiting for execution are lined up according to their price limits. If Ford shares are changing hands at $12 and two buyers have open buy orders for a thousand shares each, the one willing to pay $11.90 will have priority over the one willing to pay $11.80 regardless of when the orders have been submitted. These orders will show up in the "Bid" column on a trading screen, since these buyers are bidding for Ford shares. The orders of buyers, whose minimum acceptable prices are above current trading levels will show up in the "Ask" column.
If a buyer or seller wants to buy or sell at a more advantageous price than the prevailing price levels, the order may not get fulfilled, because a willing party to buy or sell at those prices may not come along before the end of the trading day. Therefore, you can agree to buy or sell at the best possible price. This type of order is known as a market order. At a given time, there may be buyers at $11.90 and $11.80 willing to buy 1,000 shares each at those respective levels. A 1,500-share market sell order would result in the investor selling 1,000 shares at $11.90 and another 500 at $11.80.
When there are 20 minutes before the end of the trading day, the specialist will publish all the yet-unfilled market buy and sell orders. Especially when the stock's issuer is expected to make a major announcement the next day, such as a year-end earnings announcement, there can be a significant imbalance between market buy and sell orders. A close buy imbalance means that there are more buyers than sellers. A close sell imbalance, on the other hand, means that there are more sellers than buyers. Traders will analyze the respective end of day market buy and sell orders to predict the price action over the course of the next trading day.
Hunkar Ozyasar is the former high-yield bond strategist for Deutsche Bank. He has been quoted in publications including "Financial Times" and the "Wall Street Journal." His book, "When Time Management Fails," is published in 12 countries while Ozyasar’s finance articles are featured on Nikkei, Japan’s premier financial news service. He holds a Master of Business Administration from Kellogg Graduate School.