As the global stock market has bounced up and down over the past two weeks, some clients have asked, “What causes the market to move so much in one day?” Before we get to the answer, it’s important to understand how financial markets work. This simplistic example should help.
At any given moment, there exists a “market price” for every one of the thousands of stocks traded on exchanges around the globe. A company’s market price is simply the last price at which a buyer and a seller agreed and a trade took place. Let’s assume Walmart, Inc.’s market price is $100 per share. While the last trade took place at $100, there are currently owners of Walmart who have communicated that they wish to sell their shares at a given price, while there are others who wish to buy Walmart shares at a different, lower price. Let’s say Joe is willing to sell his 1,000 shares at $101, while Jill has expressed that she wants to buy 1,000 shares at $99.
In many respects, this scenario is very similar to one many of us have experienced: Buying or selling a house. Joe is “listing” or “offering” his shares at $101 per share, and Jill has “bid” $99. Just as with a home, no sale takes place at this point, as the buyer and seller have not agreed on a price. Said differently, there is a “spread” between the bid price and the offer price. For a sale to be consummated, either Joe or Jill needs to “cross the spread” (change their price) to meet the other party’s. Just as with the sale of a home, the party that is more motivated to have the transaction take place is the one most likely to accept the other’s price.
In the case of a home, a buyer or seller might have many possible motivations to acquiesce to the other’s price. The seller might not want to carry two mortgages or might be in a cash pinch. The buyer might be from out of town and needs to have his family relocated before starting the school year, or a recent divorcee motivated to get started on the next phase of his/her life. The exact same thing is true of Walmart transactions; there is a multitude of reasons that a buyer or a seller might be highly motivated to accept a less-attractive price and effect a transaction.