Why don’t stocks begin trading at the previous day’s closing price?

Like many things in the world, the stock market relies on the power of supply and demand. The stronger the demand for a share in a company, the higher its price will be.

Alternatively if less people are interested in buying a share of a particular company, its price will drop.

Before the market opens each day, orders are placed in a queue; determining the attractiveness of a particular stock.

A company which may have performed well yesterday, could today look less attractive due to after hours news, a profit downgrade or negative pressures from offshore markets – particularly Wall Street.

Or alternatively – positive movements such as a takeover offer or profit upgrade could help yesterday’s struggling stock become today’s hot buy.

Let’s say for example that BHP Billiton shares closed the day’s trade after a fairly volatile session at $37 per share.

Then at 5pm – an hour after the market closes, BHP Billiton announces to the market that it has discovered a major copper supply at one of its mines. A large investment firm then issues a BUY recommendation on the stock.

Over in London the price of base metals such as copper and lead rise significantly in response to supply concerns. Then Wall Street opens and has a bumper session, rising by 2%.

All of these positive pieces of news would pinpoint to a strong day on our market – and signal that the resource sector, particularly BHP Billiton, is going to perform well.

It’s likely that many keen traders would have placed orders for the stock overnight, pushing up the demand for BHP shares at market open.

The orders are then placed in a queue at pre-open with the number of BUY offers far outweighing those who want to SELL their BHP shares.

This would force the open price of BHP Billiton higher, perhaps by as much as a few dollars, – as it has become much more in demand than it was at 4pm yesterday afternoon.

So essentially, the key to the value of a stock is how much someone is willing to pay for it.

The more people who want to get their hands on a stock and who have placed their orders before the market opens, the higher the opening price will be – and vice versa.

By Matt Comyn, General Manager, CommSec

Disclaimers: The views expressed in this article are those of Matt Comyn, a representative of Commonwealth Securities Limited (CommSec) ABN 60 067 254 399 AFSL 238814 and are not intented to be construed as either general or personal advice. CommSec is a wholly owned but non-guaranteed subsidiary of Commonwealth Bank of Australia ABN 48 123 123 124 AFSL 234945.