Who Decides Stock Prices?

Stock prices often fluctuate wildly, leaving many investors confused.

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There are two types of stock markets, often referred to as primary and secondary. When a company first issues a stock to sell to investors, this sale is in the primary market, between the issuing corporation and private as well as institutional buyers. Thereafter, the stock trades in a stock exchange, which is the secondary market. Prices are determined differently in the primary and secondary markets.

Primary Market

Practically every large, multinational conglomerate of today started life as a small company, owned and run by a few individuals. As a corporation grows, it might decide to "go public" -- to sell shares that will then be traded in a public stock market. The initial sale of stocks to investors takes place outside the stock market. Practically all firms seek guidance from an investment bank in this process. These bankers have a thorough understanding of the stock market and key contacts in the investment community. Investment banks also employ legal experts, who help the firm file required legal documents and papers before selling shares that will be traded on the stock market.

The IPO Price

After consulting with the investment bank and considering what it believes to be a fair price for its shares, the issuing corporation announces an initial public offering price for its shares. This is a single, non-negotiable price. It's the price paid by individual investors as well as institutions, such as mutual funds and insurance companies, which have a great deal of cash. Shares are available at the IPO price for a limited time. Once they are purchased, the buyer has to hold these shares for a while, until trading begins in a stock exchange. In other words, the issuing company decides the stock's sale price in the primary market.

Secondary Market

Soon after the IPO, the stock begins to trade in the stock market. Here, the company no longer has a say in what price the stock will trade at. The better job the issuing corporation does and the higher its profits, the more the stock price will advance. However, the level at which the stock will change hands is determined solely by supply and demand. The process is no different from the secondhand car market. A seller puts up a car for sale, along with an ask price. If a buyer is available at that price, a sale occurs. If no buyer is willing to pay that price, the seller must lower the price, or he can't sell the car. In the same way, buyers and sellers publish offering prices and place bids for stocks in a stock exchange.

Private Stocks

Despite the vast number of shares that change hands in a public stock exchange such as the New York Stock Exchange, the stocks of only a small minority of corporations in the broad economy are traded in a public exchange. All other companies are "privately held." Stocks of these firms change hands in private transactions between two individuals. Details or even the occurrence of these transactions are not published. However, prices are arrived at through the the same basic process. The ultimate price at which stocks change hands is a function of what the buyer is willing to pay, versus how much cash the seller must get before agreeing to a sale.