Who Finds the Buyers?

“When a stock is shocked by bad news and there is a torrent of sell orders, where do the market makers find all the buyers? I can imagine some answers to this question but would like the inside story.” — Derek Deer

The buyers come from two places, basically. First, with most stocks there is a book or backlog of “good-til-canceled” orders to buy and to sell. Say the stock was 40 and someone’s been holding out to buy 5,000 at 39-1/4. Someone else put in an order to buy 200 shares at 34-1/2 and forgot all about it — but it’s still in the broker’s computer. Right there, we have “found” buyers for 5,200 shares. For an actively traded stock, there would be hundreds or thousands more such orders. (There would also be some stop-loss orders lodged in the computer, triggering some automatic sells as well, adding to your torrent.)

Second, the same news that attracts the sellers jolts the much larger number of non-owners of this stock. For every one institution or individual holding Oxford Health, say, would there not have been 100 times as many people who didn’t own it? So out comes this news, and suddenly the owners who see it feel sick and yell “Sell,” but some of the non-owners are thinking that maybe there’s a way for them to take advantage of the panic. A certain proportion may figure, Gee, these troubles will pass, or at least there’ll be a little bounce . . . so if it was 40 a second ago, maybe I’ll put in to buy some at 28.

The real answer is that the buyers are “found” by the price at which the market “clears.” (With a very thinly traded stock, the market may not clear — e.g., you won’t sell your house for a dime less than $120,000, no buyer is willing to pay more than $102,000, so your house sits unsold. But if you did put in to sell it “at the market,” you’d get $102,000. The buyer would be “found” by the pull of the new lower price.)

With a New York Stock Exchange-listed stock, the specialist will provide a little (itty) bit of buying power, too. More to the point, the company may alert the Exchange that important news is coming out and trading may be halted to allow its dissemination. Or the specialist may receive a huge imbalance of orders and ask for a similar brief halt. During that time, the specialist will be issuing “indications” of where he plans to open the stock for trading . . . which in turn may cause people to enter new orders or adjust or cancel old ones. Finally, he sees that 32 is about the price at which supply and demand balance, so he opens the stock for trading there . . . and now a lot of potential sellers are saying to themselves, heck no. I’m not selling at 32 — which significantly cuts down on that torrent of supply. And enough buyers are thinking that, at 32, the market just might be overreacting, and this is a good opportunity to buy.

This is also what makes horse races. And it explains why some people actually liked that horrible Austin Powers movie. (Well, no it doesn’t. But I feel better for having said it anyway.)