How Are Stock Prices Determined?

by Bob Haring

    Investors value stocks for a number of factors, such as company earnings, dividends paid, prospects for growth and relation to general economic conditions. But in the final analysis, a stock's price is determined by supply and demand. If a lot of investors want to buy a stock, its price increases. If the outlook for that firm is dismal or if economic conditions are declining, a rush to sell drives prices down.

    There are two basic types of stock market. The New York Stock Exchange is an auction market, where orders to buy and sell stocks are matched under the regulation of a specialist broker who is charged with maintaining "an orderly market" so prices do not fluctuate wildly.
    The Nasdaq system is a broker-dealer market. Its individual brokers, called market makers, buy and sell stocks from their own accounts with no unified system of control over prices.

    A specialist does not determine a stock's price. That is done by public buy and sell orders that the specialist matches. Only when there is an imbalance of orders does the specialist intervene.
    An overabundance of orders to sell would drive down a price dramatically. In that case the specialist is obligated to buy stocks as needed to restore balance. A specialist can buy or sell only from his own account to maintain a balance.

    In a broker-dealer market such as Nasdaq, each stock will have multiple market makers. Orders to buy or sell are placed directly with the market maker, and there is no central comparison of prices among dealers. There's also no instant reporting of transactions that would tell an investor, or a dealer, how prices are changing among various brokers.

    Although "fundamentals" such as corporate earnings and dividends are important in settling on a stock price, many prices also are affected by "momentum" or "herd mentality" where buyers or sellers react to external conditions. A major positive earnings report, for instance, can trigger a flood of "buy" orders and send a price soaring. A negative economic report can send almost all stock prices down.

    Investors and securities analysts use many formulas to calculate or predict stock prices, ranking factors such as profits, dividends, business outlook and economic trends.
    The price/earnings ratio -- the relationship of share price to company earnings -- is one important factor. Individual stock history is another factor. Some companies have histories of highly variable stock prices; others tend to be stable for long periods.

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    About the Author

    Bob Haring has been a news writer and editor for more than 50 years, mostly with the Associated Press and then as executive editor of the Tulsa, Okla. "World." Since retiring he has written freelance stories and a weekly computer security column. Haring holds a Bachelor of Journalism from the University of Missouri.

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