New investors may puzzle over the rapidly changing values of stocks on the various exchanges and suppose some underlying mathematical calculation determines the stock's intrinsic worth. In fact, there is no such calculation and the price has nothing to do with intrinsic worth. At any given moment, the price simply represents what buyers will pay for each share of the stock and what sellers will accept -- a price only indirectly rated to tangible forces and more closely related to sentiment.
The Order Book
Each stock exchange, including the New York Stock Exchange, has a computerized transaction capability -- software that allows it to buy and sell equities with little human participation. An "order book," in computerized database form -- the electronic limit order book, or ELOB -- holds records of the most recent bids, or prices that buyers have offered to pay for the equity, and asks, prices that sellers have offered to accept.
Many retail stock market customers offer to buy or sell an equity "at the market," meaning for whatever the current listed price may be at the moment they make the offer. When buying in small amounts -- of less than 10,000 shares, for example -- doing so is both reasonable and convenient. Market orders, as they are called, will usually be within a cent or two of the last order listed before the new order, which means the retail customer already knows approximately what she will be paying. Another advantage for retail customers is that the order will go through immediately; market orders are always executed first.
Limit orders on the other hand, are offers to buy or sell only at a specified price. Large market participants, such as hedge funds, make an offer to buy or sell a particular quantity of an equity -- 10,000, 100,000 or more shares -- at a specified price, the "limit price." The order will only be executed when a matching seller or buyer is listed in the ELOB. The limit order is at the heart of the transactional process that establishes an equity's current price.
From the hundreds or thousands of bid-ask offers for a specific equity that exist at a given time in the ELOB, the software will seek matches. When a bid and an ask match, that order is executed and becomes the last traded price, or LTP. The LTP is immediately listed and becomes the current stock price. It remains so until the ELOB software finds a lower or higher match, whereupon the LTP shifts up or down to the new matching bid-ask, which then becomes the current price.
Patrick Gleeson received a doctorate in 18th century English literature at the University of Washington. He served as a professor of English at the University of Victoria and was head of freshman English at San Francisco State University. Gleeson is the director of technical publications for McClarie Group and manages an investment fund. He is a Registered Investment Advisor.