The Mechanics Of How Stock Prices Change

Scope And Purpose Of This Post

I've had a few people ask me, "how do stock prices change?".  They do not mean how to look at a company and try to figure out what the stock price should be; they are wondering what are the little actions going on during a price change that result in a price change.  Unfortunately, if you google "how do stock prices change", you will get a bunch of pages that answer slightly different questions, or pages that stay at the vague level of supply and demand.

This post tries to explain how price changes actually happen, mostly through examples that take place on an exchange.  The most famous exchange-traded-things are stocks, ETFs, and financial derivatives (options, futures, etc), but the underlying concepts apply to more than just things on exchanges.

A related post is Notes On How Modern Financial Markets Work, which has article snippets/paraphrasings that cover exchanges and other workings of modern financial markets.

Following Sections:

• 2 Background Info sections: will help explain a lot of concepts that I use in my examples (bids, asks, limit orders, market orders).  People familiar with such concepts might want to skip ahead to the example sections.
• Examples {1, 2a, 2b, 3}: the heart of the post, painting detailed pictures of prices changing, with some general observations as well. 
• Brief Recap: briefly summarizes of the ways that prices change, restating the lessons learned in the examples.  The section might be too abstractly worded if you haven't gone through the examples, but once you have, I hope the section will help quickly refresh you on how prices change.
• Appendix A on Price Improvement: a sidenote explaining the mechanics of "price improvement" that your brokerage may boast about after a trade.  This section may be moved in the future if I ever have a post that goes into more detail about how exchanges work.

Stock Market Index Reference

Purpose And Scope Of This Post

There's a lot of indices out there, and they will mislead you. The  S&P 500 is intuitive because it's basically the 500 biggest US companies, but the S&P 600 is unintuitively the 600 smallest of the 1500 biggest US companies.  The S&P 600 is also called the "S&P SmallCap 600", but by more popular definitions, it is the smallest 15% of  mid-cap stocks.  The Wilshire 5000 has 3485 companies in it.

This post tries to be a useful reference (mostly for myself) for what the heck a particular index is, how indices relate to each other, and to answer some common questions like, "what percent of the US stock market is represented by this index?".  You should think of it as a work in progress.

Steps to Buy an ETF at Fidelity

Purpose And Scope Of This Post

I want to help answer the question, "How, exactly, do I buy an ETF?  What buttons do I click?  What options do I choose?   What numbers do I enter, especially for things like quantity and limit price?".  There seems to be lots of written material about how to choose an ETF and the different types of buy orders, but very little written material that tries to answer the questions in quotes above.  The best I can find is stuff like the "ETF Best Trading Practices" section of this pdf from Vanguard, which still leaves things at the abstract level of "use a limit order that is likely to be executed instantly".

This post will go, click-by-click, through the process of transferring money into a Fidelity account and submitting a buy order for an ETF.  Hopefully, this click-by-click will help make people's first time easier and less scary (especially due to clear statements of which clicks have real-world consequences).  Also, this post will give the exact logic/calculations I use for coming up with the quantities and limit prices for my buy limit orders.  The logic/calculations for quantity and limit price are applicable at all brokerages, not just Fidelity.

If you are wondering what ETF to buy, see this long post or this short post.

2022-Jan update: Fidelity now has a quantity calculator, which helps with a lot of the calculations mentioned below.  Also, Fidelity now lets you buy fractional amounts of ETFs where you specify how many dollars you want to spend.  The "Explanation Of How We Calculate Desired Quantity And Limit Price" could use some updating..

Oversimplified Conversations About Portfolios

Scope Of This Post

Hubert Featherbottom

This post is not financial advice, and I refuse to take any responsibility for any financial ruin or prison time you experience.  Please do your own research and make your own conclusions.

This post is mostly a series of hypothetical conversations between fictional characters.  Fictional people ask the fictional Hubert Featherbottom about what sort of portfolio might make sense for them, and they want the simplest responses possible, disregarding all nuance, caveats, and even sanity.  By "portfolio", I mean "collection of financial assets (stocks, bonds, bank deposits, etc) someone owns in order to save up for particular needs and goals".

If you see a fictional person who asks questions similar to things you're wondering, you might find their conversation useful.  If you just want to save for the long-term in the simplest way, please look at the 401k section and Conversation 1.  If you're interested in mutual funds instead of ETFs, see Appendix B.

If you want a huge walls of text about saving/investing, see Starting Point For Saving And Investing.  If you want a click-by-click of how to buy an ETF, see Steps To Buy An ETF At Fidelity.  If you want a slightly more in-depth article about simple portfolios, see Boglehead Wiki article on Three-Fund Portfolio.

If you'd like the tables updated to include a particular broker or line of ETFs, tell me, and I'll see what I can do.