A lesson in stock trading mechanics

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A simExchange player (jayen) recently asked about how prices adjust in the real stock market compared to how trading on the simExchange works. This question came from a special event on April 26 following Ubisoft Entertainment&#8217-s earnings announcement. Ubisoft had announced that it has sold 950,000 copies of Red Steel when the stock was only forecasting 478,600 copies (47.86 DKP). This resulted in a free arbitrage opportunity in which anyone buying the stock would be locking in guaranteed gains.

At the same time, anyone selling the stock at 47.86 DKP would be giving away money. Naturally, no rational person would be selling at 47.86 DKP if the news already reveals the stock should be worth over 95.00 DKP. Unfortunately, the simExchange relies on NPC market makers (NPC is a gaming term meaning &#8220-Non-Player Character&#8221-) that do not take news into account when they make markets and so the prices would not immediately reflect the news unless traders bought every automated ask order up to 95 DKP.

Remember, stock markets function in an auction system where a bidder and seller each have a price they are willing to buy and sell at. When there is a match&#8211-a buyer and a seller willing to transact at the same price&#8211-a trade is filled. Due to these mechanics, a stock’s price can easily jump from one trade to the next as the last traded price does not directly affect what price buyers and sellers can trade at next.

Following large news events, such as earnings releases, you will often see a jump in the stock price. A stock may have just traded at $100. News is released that shows the company is growing much faster than previously believed. The market makers now believe the stock is worth around $120 a share. They don’t just keep posting sell orders around $100 and let buyers gradually push the price of the stock to $100, they immediately post that they are willing to sell at no less than $120 a share. Buyers who believe the stock is worth more than $120 a share will immediately adjust their bid orders to $120 as they know they are not going to get the shares at $100. The stock price would immediately jump from $100 to $120 with no trades at any price in between.

As previously mentioned, the NPC market makers on the simExchange are not aware of news that should adjust their bid and ask prices. It is unrealistic for them to keep posting sell orders below 95 DKP if the news already shows the stock should be worth 95 DKP. As a result, the bid and ask orders were manually adjusted to compensate for this new information, as would be done in the real stock market.

It is easiest to notice and understand this by viewing what are called Level II Quotes (advanced trading mode on the simExchange). This view lets you see the order book: the collection of orders people are posting as offers to buy or sell. A trade only fills when someone submits an order that matches an order in order book. If there are no sell orders submitted at 50 DKP, then you cannot buy at 50 DKP. You can always submit an order to buy at 50 DKP and wait for a seller to come by who is wiling to take your offer. However, if there are no orders to sell below 90 DKP, then 90 DKP is the only price you can immediately buy at. This system is often referred as a &#8220-double call auction.&#8221-

Cross posted from A lesson in stock trading mechanics on the simExchange Official Blog.

Previously: Next lesson: so the “futures” aren’t really futures, So what exactly are these “futures?”, The structure of the simExchange stocks and An invitation to join the simExchange beta.

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