A stock needs to have a combination of a buyer and a seller in order to exchange hands. Then how is the supply and demand created?

Question

I have no background in the stock market and I have just started to learn about it. Please excuse me if this is a stupid question.

What I know so far is that if I have to sell a share, there has to be a buyer in the market. If no one is willing to buy a share, I cannot sell it.

My question is that suppose there was sudden bad news for company ABC. Everyone is expecting that this company may lose 50% of it's share value. People who own ABC's shares will want to sell their shares. Now, in order to sell the shares, there has to be someone who is willing to buy them.

From what I presume how it works is that someone puts a sell request and someone at the same time who puts a buy request can exchange hands. Then how does the market know that there are a lot of sellers and no buyers?

Is there like a pool where you see that people have put a selling request and no one has put a buying request? Because if there is a pool, it makes sense that supply and demand can be calculated. Otherwise, if there is no pool, how do we know if there is more supply of a share than the demand and vice versa?

Once again, please excuse me for this question, but I am very confused about how this works.

Answer 1

You have a pile of bids from people looking to buy and a pile of asking prices from people looking to sell. If they match up, a sale happens.

To make this efficient, either side can put in a market order which means that you'll just get matched up with a buyer/seller at the prevailing rate rather than having to fuss with picking the right bid/ask which will typically be moving around. Alternatively if you have a very specific price in mind you can put in an order at that price and it may or may not get filled.

You can also choose when an order expires, so if I decide that I want 100 Tesla shares if they ever go under $400 I can put in an order that doesn't expire. So, perhaps in a month the price drops low enough my order would fill.

Here's an example, J. C. Penney Company (JCP) shows that there's demand for 1200 shares at $0.272 while there are 3100 shares available at $0.274. There are mechanisms in-place to find middle-ground for market orders or dealing with sub-penny pricing differences, but the important part for your question is that there are piles of each as you suspected.

Answer 2

The order book is an electronic list of buy and sell orders for a security. It is organized by price level and lists the number of shares being bid on or offered at each price point (called market depth). Here's an Example of what it looks like.

Now per your supposition: Suppose there was sudden bad news for company ABC. Everyone is expecting that this company may lose 50% of it's share value. People who own ABC's shares will want to sell their shares. Now, in order to sell the shares, there has to be someone who is willing to buy them.

There are now an overwhelming number of sell orders (limit and market). All of the bids (buy orders) near current price are taken out. If no new buyers come in at current price, price shifts down to buy orders on the order book at lower prices. At the same time, sellers with limit orders lower the price of their sell orders. This process continues (matching of orders and share price drop) until equilibrium is reached between aggregate selling and buying volume at which time price levels off.

In your extreme case of VERY bad news, this process may get out of control. In that case, trading in the stock is halted, giving the market maker time to pair off trades and figure out at what much lower price the sell order imbalance evens out. That's the starting price point when trading resumes and additional buy and sell orders will then determine whether share price continues down, levels off or begins to recover.

Answer 3

To build on what @bob-baerker and @mikesplace mentioned, in most cases, your counterparty will most likely be a market maker when you place a market order.

A market maker usually has a contractual obligation with the exchange to have a bid and ask at all time (or most of the time). They make their money on the spread (the difference between the bid and ask price), but that's in exchange for taking a risk on their inventory, which in a case of bad news can get pretty extreme. To minimize that risk, they can widen the spread, and modulate the quantities they have on the ask and the bid. So if you are trying to sell 1000 shares, but the top bid is only for 100 shares, you'll get some slippage and need to go further down the order book at a price lower and lower (these bids could also be from market makers, or from other investors).

In the old days, the NYSE had "specialists" that were the single market maker for each stock. The electronic exchanges changed that, and nowadays, the market makers will compete for your orders, which keeps the spread tight (decimalization definitely helped too).

Market making seems to be a very profitable business if you can do it at scale, as exemplified by Citadel Securities, which is one of the biggest, if not the biggest, at least in the US.

Answer 4

The pool that you ask about is the order book, only orders that have a set limit are visible though. I think you are talking about a situation when the order book is empty and there is an at market seller and an at market buyer, what price would it execute at because nobody has placed a limit order. I think this may be one reason why a market maker exists and that person will place an order just to keep trading functioning. Market makers used to be people, but I bet they are replaced by computers now that buy and sell stock just to keep things liquid on the exchange and to deal with situations like empty order books. I just did a bit of reading and confirmed that market makers do in fact perform this role