How Are Stock Prices Set?

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Stocks represent shares in a company and are traded through stock exchanges, such as the New York Stock Exchange. Companies such as investment banks can become members of a stock exchange. Investment banks are then allowed to trade the stocks listed on the stock exchange, and they set two prices for any given stock: the amount they will accept from buyers of a stock and the amount they will pay to sellers. Investment banks take a number of factors into consideration when setting the price of a stock.

Asset Value

  • Because stocks represent a share in a company, the assets owned by the company are components for setting the price of a stock. Assets include factories, real estate, patents, physical stock and cash. You can work out the net asset value of a company by subtracting any liabilities, such as money owed to other companies, from the company's assets. If you divide the net asset value of the company by the number of shares issued, you get the net asset value per share. This will typically be lower than the actual stock price for a company that enjoys strong sales growth and expansion, because the net asset value does not take current earnings and potential future earnings into account.

Announcements

  • Stock traders who make a market in stocks follow announcements made by companies. Sometimes stock exchange rules require a company to make announcements of certain events. For example, if a company receives a takeover bid, the company must announce this publicly. Stock traders anticipate an increase in demand for the shares in the company and will set the price of the stock higher following the announcement. News of a takeover bid will typically increase demand for a stock because the bidding company usually has to offer a premium over and above the current stock price to mount a successful bid. A company announcing bad news, such as the loss of a major contract, will see a fall in demand for its stock. Stock traders react by lowering the price that they set for the stock, anticipating an increase of sellers of that stock.

Trading Volume

  • Stock traders take note of the trading volume of a company's shares when pricing them. Whenever there are more sellers than buyers in the market, stock traders, such as investment banks, will typically lower the price that they offer to sellers who want to sell their shares. They raise the price offered to buyers when the number of buyers exceed the number of sellers. Based on the trading history of a particular stock, stock traders expect a certain number of shares of that stock to be traded each day. If the volume of trade increases or decreases significantly, stock traders will adjust their trading prices for that stock accordingly, to take account of the increased buying or selling activity.

Spread

  • Stock traders make a profit from the difference in the price that they offer to sellers wanting to sell stocks, and to buyers who want to buy stocks. For example, a stock trader may offer to sell a stock for $111 but offers $100 to buy the stock. The difference between the buying price and the sale price is known as the spread. The price quoted by a stock exchange for a stock is usually the mid price, that is to say, the price mid way between the buying price and the selling price of the stock. The mid price is the average of the mid prices set by all the stock traders trading in a particular stock.

References

  • Photo Credit new york stock exchange image by Gary from Fotolia.com
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