The previous day’s close, as well as any after-hour trading in a security may have significant effects on the opening price, but that isn’t the whole story. Here’s a quick summary of how the process for determining the opening price works.
The basic problem is that the closing price from the previous trading day is no longer a valid indicator of a stock’s perceived value. News may have appeared since the previous close, there may have been trading on foreign exchanges that open before US domestic exchanges, and there surely has been a flow of new and changed orders since the previous close.
On the NYSE and ASE, the specialist determines the opening price by looking at his/her “book.” The specialists are supposed to select the one price that clears out the maximum number of orders; i.e. by looking at the buy and sell offers and choosing a single price will execute the most orders (shares). But it is possible that today’s book contains no orders from yesterday – or at least none that might affect the opening. So the specialist may have to make an educated guess to kick off initial trading.
As a multi-market maker exchange, NASDAQ’s computerized system opens differently. Market makers perform a two stage round-robin opening.
First, each posts a single bid and asked price pair. This price can signal each firms view of the security, its current desire to buy or sell, or it may indicate that a firm is out of calibration with others in the market. After all have seen the first round, each firm may revise their postings once and trading starts as the executions flow to “best” postings. And off the day’s trading goes.
You may read about “gaps” in the opening price, or that trading in a security began late. This commonly happens when news that was released after the previous market close impacts a security’s price. The opening price in these cases differs sharply from the previous day’s close, either higher or lower. For example, a company may release unexpectedly good earnings early in the morning just before the market opening. If there is a potential price impact expected, the firm, its specialist/market makers, or the exchange itself may delay the opening to allow the news to reach as many people as possible before an opening is made.
An extreme example of what a specialist may have to deal with happened in February 1997. Mercury Finance (MFN) closed around 15 and opened the next day near 1 1/2 due to extremely bad news overnight. (I am ignoring what might have happened in after hours trading – but that would have some effect.) Some poor souls might not have heard the bad news and left open their old buy or sell orders at 14-15. The NYSE specialist could potentially have opened the stock at $14, taken out those orders and then done the next trades at 1 1/2 (or where-ever it did open: 1-3/8 or 1-5/8). But looking at the books, he eventually decided on a delayed opening, allowing people time to assess the news and adjust open and new orders accordingly. Once a pattern of orders emerged, the opening occurred according to normal procedures. An unrevised open buy order from yesterday executed at todays far lower price… An inattentive market-price seller from yesterday would get today’s sharply reduced price, too.
Article Credits:
Contributed-By: Chris Lott, John Schott
