One of the most important questions every trader should understand is why the price of an asset rises or falls. he short answer is simple: prices change because of supply and demand.
Whenever more market participants want to buy an asset, demand increases and the price tends to rise. Conversely, when more participants want to sell, supply increases and the price generally moves lower.
In practice, however, prices do not depend solely on the number of buyers and sellers. They are determined by the buy and sell orders submitted to the market and the amount of those orders, commonly referred to as trading volume.
How Are Orders Executed? #
Suppose the current market price of an asset is $100.
At this price, some traders have placed buy orders, while others have placed sell orders.
Whenever a buy order and a sell order meet at the same price, a trade is executed. This process is called order matching, and the successful execution of an order is known as an order fill.
As long as both buy and sell orders remain available at the same price level, transactions continue to occur at that price.
When Does the Price Change? #
A price changes when the orders on one side of the market are completely exhausted before those on the other side.
For example, imagine that at $100 there are 50 buy orders and 60 sell orders.
First, 50 buy orders are matched with 50 sell orders, and those trades are executed at $100.
However, 10 sell orders still remain, while there are no more buyers willing to buy at $100.
As a result, sellers must move to the nearest price level where buy orders are still available. Suppose that price is $99.
As soon as the first trade is executed at $99, the market price moves from $100 to $99.
This is why traders often say that selling pressure has pushed the price lower.
The same event can also be explained from the perspective of supply and demand. When the number of sell orders exceeds the number of buy orders, supply becomes greater than demand. Sellers are therefore willing to accept lower prices in order to find buyers, causing the market price to decline.
What Happens When Buyers Outnumber Sellers? #
Now consider the opposite situation.
At the $100 price level, there are more buy orders than sell orders.
All available sell orders are matched with buy orders.
However, some buy orders are still waiting to be filled, while no sellers remain at $100.
In this case, buyers move to the nearest price level where sell orders are still available. Suppose that price is $101.
As soon as the first trade is executed at $101, the market price rises from $100 to $101.
In this situation, traders say that buying pressure has pushed the price higher.
From the perspective of supply and demand, when the number of buyers exceeds the number of sellers, demand becomes greater than supply. Buyers are therefore willing to pay higher prices to obtain the asset they want, which drives the market price upward.
The same principle is also described in economics through the concepts of abundance and scarcity. When the supply of a product increases relative to demand, the product is considered abundant. Under these conditions, sellers must compete by offering lower prices, causing the price to fall. Conversely, when supply decreases relative to demand, the product becomes scarce. Buyers are then willing to pay higher prices to obtain it, resulting in higher prices. This principle extends far beyond financial markets and is one of the fundamental concepts of microeconomics. For example, if unfavorable weather reduces the harvest of a crop, the available supply declines and its price in grocery stores or produce markets will typically increase. On the other hand, if the harvest is exceptionally large, supply rises, abundance increases, and prices generally fall. Financial markets operate according to exactly the same principle, with one important difference: instead of physical goods, it is buy and sell orders for financial assets that compete with one another.
The law of supply and demand discussed in this lesson applies to virtually every market where goods or services are exchanged. In terms of its importance in economics, it can be compared, to some extent, with the law of gravity in physics, since many economic phenomena are built upon this fundamental principle. However, under certain conditions—such as government price controls, monopolies, or asymmetric information—the normal functioning of the market may be disrupted, and prices may not be determined solely by the forces of free supply and demand.
Why Are Prices Constantly Changing? #
In financial markets, millions of buy and sell orders are continuously submitted, modified, and canceled by market participants.
As a result, the balance between supply and demand is constantly shifting, causing prices to move up and down continuously.
Simply put, every price movement is the result of new orders entering the market and trades being executed between buyers and sellers.
Summary #
Asset prices in financial markets are determined by the interaction of supply and demand. Whenever buy and sell orders are matched at the same price, a trade takes place. If one side of the market runs out of orders before the other, the price moves to the next available level where matching orders exist. Consequently, stronger buying pressure generally pushes prices higher, while stronger selling pressure generally pushes them lower.
One-Sentence #
Prices in financial markets are the result of the continuous matching of buy and sell orders, and any change in the balance between supply and demand can cause prices to move.