What is 'Market Price'
The market price is the current price at which an asset or service can be bought or sold. Economic theory contends that the market price converges at a point where the forces of supply and demand meet. Shocks to either the supply side and/or demand side can cause the market price for a good or service to be re-evaluated.
BREAKING DOWN 'Market Price'The market price of a security is the most recent price at which the security was traded. It is the result of traders, investor and dealers interacting with each other in a market.
Two Sides of a Trade
To comprehend how a market price is derived, it is important to understand some basic trading concepts. There are two sides to every trade; when a trader buys or sells a security, a dealer takes the other side of the trade. When a trader buys a stock, dealers sell the stock. In most cases, the dealer is an intermediary representing other traders. When traders place limit or stop orders away from the market price, the dealer holds the orders in its order book until such time as the market price approaches the order price and the orders are executed.
Dealers, or market makers, quote market prices using a bid and an ask price. The bid is always lower than the ask, and the difference is the spread. From the dealer's perspective, the bid represents the price at which the dealer will buy. The ask price represents the price at which the dealer will sell. Dealers adjust these prices at their discretion. From the trader's perspective, a trader wanting to execute a trade at the market price must buy at the ask and sell at the bid.
How a Market Price Is Derived
The interaction between dealers and traders is what manipulates the market price. For example, assume the market price for XYZ stock is $50/51. There are eight traders wanting to buy XYZ stock; this represents demand. Five buy 100 shares at $50, three at $49 and one at $48. These orders are listed on the bid. There are also eight traders wanting to sell XYZ stock; this represents supply. Five sell 100 shares at $51, three at $52 and one at $53. These orders are listed on the offer. At this point, supply and demand are balanced, and traders do not want to cross the spread to execute their trade. Say a new trader comes in and wants to buy 800 shares at the market price, which is the shock. This trader has to buy at the offer: 500 shares at $51, and 300 at $52. Now the spread widens and the market price is $50/53. Dealers immediately take action to close the spread. Since there are more buyers, the spread is closed by the bid adjusting upward. The end result is a new market price of $52/53. This interaction is constantly taking place in both directions.