You tap "buy" on an app and a second later you own shares. It feels like magic. It isn't — there's a surprisingly interesting mechanism underneath it. Understanding how markets actually work won't make you a better stock picker, but it will help you trade more intelligently, avoid common beginner mistakes, and understand why prices behave the way they do.
Stock prices are set by supply and demand at any given moment. If more people want to buy a stock than sell it, the price rises until sellers are willing to part with their shares. If more people want to sell than buy, the price falls until buyers emerge. That's it. There's no central authority deciding what anything is worth — it's a continuous auction.
This sounds simple but has a profound implication: the price of a stock at any moment reflects the aggregate opinion of everyone trading it. That includes hedge funds with supercomputers, pension funds with armies of analysts, and a teenager on their phone. The market price is the equilibrium of all their views, weighted by the capital they're deploying.
When you buy or sell, you choose how you want to transact:
For large, liquid stocks (Apple, Barclays, NVIDIA), market orders are usually fine — the spread is tiny and there's always someone to trade with. For small-cap or thinly-traded stocks, always use limit orders.
At any moment, there are two prices for any stock:
The spread is the gap between them. If NVIDIA has a bid of £899.50 and an ask of £900.00, the spread is 50p. When you place a market buy order, you pay the ask. When you market sell, you receive the bid. The spread is an immediate, invisible cost every time you trade.
For Apple or FTSE 100 stocks, spreads are fractions of a penny as a percentage of price. For a thinly traded small-cap, the spread might be 1–2% — a significant cost before your investment has even started.
The spread is why active trading is costly. Every time you trade in and out, you cross the spread twice — once to buy (paying the ask), once to sell (receiving the bid). Over many trades, this adds up substantially. It's one of the structural reasons frequent trading underperforms buy-and-hold over most time periods.
Market makers are firms (banks, specialist trading companies) that commit to always offering both a bid and an ask for a security. They make money on the spread — buy at the bid, sell at the ask, profit the difference. Their role is to provide liquidity: without them, you might want to buy a stock but find no one is willing to sell at a reasonable price right now.
In highly liquid markets, there are many competing market makers and spreads are tiny. In less liquid markets, there may be fewer market makers and wider spreads. During market panics, market makers can widen their spreads dramatically or temporarily withdraw — this is part of why liquidity dries up in crashes, making prices move more violently than fundamentals alone would suggest.
In the US, stocks can be traded before the official market open (4–9:30am ET) and after close (4–8pm ET). This is when earnings reports typically drop — after the close, when the company doesn't want to disrupt trading during the day. Pre-market and after-hours trading tends to have lower volume, wider spreads, and higher volatility. The big gap up or down you see when a company reports earnings is usually set in after-hours trading the night before.
Practical takeaway: for most investors buying liquid ETFs or large-cap stocks, the mechanics above are background noise. Use limit orders for anything illiquid or when precision matters. Avoid trading in the first and last 15 minutes of the day when spreads tend to widen and volatility spikes. Most importantly: transaction costs — spreads, commissions, taxes — compound against you just like fees do. Minimise them by trading as infrequently as your strategy requires.
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