Prat had an interesting question on how a share price is calculated on the stock exchange at any given point, and his question had more to do with the mechanics of share price calculation, and not on value or demand and supply etc. which is what is commonly talked about.
So, when you see that the price of Infosys is Rs. 2,850 – how was the price calculated at that given time?
The calculation of prices is completely automated, software driven, and anonymous at both BSE and NSE, and the price is calculated by electronically matching bids and offers for a particular share recorded an electronic limit order book (ELOB).
When you place an order to buy a share at a certain price that is called your “bid” and when you place an order to sell your shares at a certain price that’s called your “ask”.
The ELOB contains all the bid – asks for a particular share and the system matches the best bids and asks to execute an order. The price at which a transaction is executed is called the last traded price (LTP) and that’s what you see on TV screens.
From the NSE’s website – let’s take a look at an example ELOB to understand this process.
An example of an order book for a stock at a point in time is detailed below:
If you look at the above table, the left side are the bids and the right side are the asks. As it stands – there can’t be any transaction because the highest price that the buyers are willing to pay is lower than the lowest price at which the sellers are willing to sell. However, if you come in and put up a market order to buy 3,000 shares – your order will be executed and you will get 2,000 shares at Rs. 4.00 and the remaining 1,000 shares at Rs. 4.05.
Similarly if you wanted to sell 2,000 shares – the first 1,000 will be sold at Rs. 3.50 and the second thousand will be sold at Rs. 3.40.
The exchange gets you the best price that is available at that given time whether you are a buyer or seller and if you have placed limit orders then those orders will not be executed as long as someone matches that on the other side of the transaction.
At a high level, matching the bids and asks on a stock based on the volume at that time determines the stock price. I’m sure there are a lot of intricacies in this system, but I’m unable to write about them because I’m not familiar with them myself. If you have a link that goes deeper than this then please do leave a comment.
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