Price is Determined by the Interaction of Buyers and Sellers

Profitable traders use technical analysis to judge prices because they know that price is not dictated by market events, but rather the interaction between buyers and sellers which determines price.  The action of just a few traders can have a very significant impact on price, as their volume of shares can push the price through uptrends or downtrends, based solely on the exchange price for one trade.

What happens when a trade is entered

When a trade is executed, a buyer and seller agree on a price for the security.  Often we hear about the bid and ask prices; these are the prices that buyers and sellers set for the shares.  Sellers are interested in the ask price, or the amount of money they are “asking” for their shares.  Buyers focus on the bid price, the amount that buyers are “bidding” for shares.  Contrary to popular belief, the amount of buying and selling means nothing.  When you hear that the market was down on high volume, it isn’t because the amount of sellers outweighed the buyers; rather, it was because the buyers put less of a value on the stock than the open price.

Neither buyers nor sellers set the price

Price comes from a mutually agreed value that two traders can agree on.  If the price of WalMart stock is $50 and a buyer and seller complete a trade for $60 per share, the stock would uptrend to $60; as the last agreed price was now $60, buyers and sellers would work to meet around this price. 

Obviously big disparities in price like this rarely, if ever, occur.  But when looking at a larger picture, it’s easy to see how prices change over time.  If sellers want $50.70 for a stock and buyers are only willing to bid $50.60, one of the two sides must agree for a higher or lower price.  A seller could drop their ask price to $50.60 and have a variety of buyers to sell to, or a buyer could up the price to $50.70 and have a number of sellers willing to dump their shares.  In the event of a sideways trend, it’s usually the result of buyers and sellers finding a common price, where the market moves in a sideways trend just because the price is almost perfect.

How to make money with this

Knowing how prices are set will profoundly impact your trading and confidence in technical analysis, as well as even your own creative techniques.  But what you’ll also understand is the trading discipline that is required to let the price move to an area that you want to trade.  Discipline is very important when waiting for stocks to move; it can take hours just for a .20 cent movement.  Professional traders know where to set their price targets and take profits to allow for the price to come within view; it should be the goal of any profitable trader to do the same.  Understanding how and why these volatile markets work will help produce more consistent profits in the long term.