Market Foundation
Why prices move, what shifts supply and demand, how the order book connects buyers and sellers, and why the spread quietly decides whether you're profitable.
Most "why do stocks move?" lessons stop at supply and demand like that's the end of the conversation. It's the beginning. This lesson is the full chain: what supply and demand actually look like, what shifts them, how buyers and sellers meet inside the order book, and why the one-cent spreadSpreadThe difference between the best ask and best bid. Effectively the round-trip cost paid to market makers on every trade.Read in glossary → between bid and ask quietly decides whether your strategy has an edge or bleeds out.
1. Why prices move - the only answer
There is exactly one reason any freely-traded asset's price changes: more people want to buy it than sell it, or vice versa. Everything else - news, earnings, the Fed, Reddit threads - is a cause that shifts one of those two sides. News doesn't "move stocks." News moves demand, and demand moves stocks.
The classic picture from economics makes this precise. Price sits at the intersection of a downward-sloping demand curve (buyers want more when it's cheaper) and an upward-sloping supply curve (sellers offerAskThe lowest price a seller is currently willing to accept. When you buy with a market order, you buy at the ask.Read in glossary → more when it's expensive). The crossing point is the current price.
Shift the curves, and you shift the price
When something increases the appetite to buy (good news, upgraded fundamentals, improving sentiment, macro tailwind), the demand curve shifts right. Same supply, more buyers - new equilibrium at a higher price and higher volume.
The mirror image: bad news, deteriorating fundamentals, fear, macro shock - demand curve shifts left, price drops.
2. The four things that shift the curves
Supply and demand don't move on their own. Four forces, at different timescales, push them around.
| Driver | What it moves | Timescale | How to measure |
|---|---|---|---|
| News & events | Demand (shock) | Seconds → days | Earnings surprise %, headline polarity, volume spikes |
| Fundamentals | Demand (drift) | Quarters → years | Revenue / EPS growth, margins, P/E, DCF fair value |
| Sentiment | Demand (swing) | Minutes → weeks | VIXVIXThe Cboe Volatility Index - 30-day implied volatility of S&P 500 options. Often called the 'fear gauge'. Below 15 = complacent; 20-30 = nervous; 40+ = panic. VIX spikes are usually short and mean-revert; sustained high VIX marks regime-change.Read in glossary →, put/call ratio, advance/decline, fund flows |
| Macro | Both | Months → years | Fed funds rate, CPICPIThe Consumer Price Index - monthly inflation reading. The single most market-moving non-Fed economic release. Released around the 10th-15th of each month at 8:30 a.m. ET; bonds, stocks, and rate futures often gap on the print.Read in glossary →, yield curve, PMI, employment |
News - demand shocks
An earnings surprise is the deltaDeltaHow much an option's price changes per $1 move in the underlying. Also a working approximation of the probability the option finishes ITM at expiration.Read in glossary → between what analysts expected and what the company actually reported. A +15% EPS surprise on a mid-cap typically moves the stock 5-10% in the first minutes, often more. An FDA approval on a small-cap biotech can move it 50-200% overnight. News doesn't change the company in the minute it hits the tape - it changes what buyers are willing to pay, immediately.
Stock closes Tuesday at $100. After the bell, the company beats EPS by 20% and raises guidance. Overnight, traders and algos update their demand. By Wednesday's open:
- The demand curve has shifted right.
- Bids climb from $99 → $104 → $108 as existing holders pull their sell orders (supply curve also shifts slightly left).
- First print at 9:30 is $109.40, up 9.4%.
- No one "caused" that move except thousands of independent actors independently updating what they'd pay.
The important part: the price change happened before the opening bell, in the hours buyers and sellers rewrote their bids and offers overnight.
Fundamentals - demand drift
The slow, boring driver. A company's revenue and earnings grow (or don't), and fair-value estimates drift with them. P/E ratio is the single most-quoted fundamentals metric:
P/E = Price per share ÷ Earnings per share (EPS)
A crude but ubiquitous shorthand for 'how many years of current earnings am I paying for?' SPX historical median is around 15-17×. Anything above 25 is priced for growth.
Fundamentals rarely move prices hour-by-hour. They anchor where price can drift to over months. When sentiment and news pull price away from fundamental fair value, fundamentals pull it back - eventually. "Eventually" can be years.
Sentiment - demand swings you can measure
"Sentiment" sounds fuzzy; it's not. There are hard numbers:
| Indicator | What it shows | Typical range | Reading |
|---|---|---|---|
| VIX | S&P 500 options-implied 30-day volatility | 10-80 | <15 = complacent, 20-30 = nervous, >30 = fear, >40 = panic |
| PutPutAn options contract giving the buyer the right but not the obligation to sell 100 shares of the underlying at the strike price on or before expiration.Read in glossary →/Call ratio | Puts traded ÷ calls traded | 0.5-1.5 | <0.7 = greedy, >1.0 = fearful |
| Advance/Decline | Stocks up ÷ stocks down | 0.3-3+ | Broad participation vs. narrow rally |
| AAII Bull-Bear | Retail survey, bulls − bears | −40% to +40% | Contrarian at extremes |
Retail traders watch sentiment directly. Professionals watch it as a contrarian signal: when the crowd is maximally one-sided, the marginal dollar to push further in that direction doesn't exist.
Macro - the tide under everything
Interest rates, inflation, employment, GDPGDPGross Domestic Product - the total value of goods and services produced. Released quarterly with two revisions. Less reactive than monthly data because it's lagging, but headline-grabbing when it surprises.Read in glossary → growth - these set the discount rate applied to every future dollar of earnings. When the Fed raises rates, the present value of a distant earnings stream falls, and long-duration assets (growth stocks, bonds, real estate) reprice lower. When inflation spikes, margins compress and demand for most equities shifts left at once.
3. Where supply meets demand - the order book
Supply and demand are abstract curves. The order book is where they show up, concretely, for every stock, every second. Every trader with a resting order is a point on one of those curves.
- BidBidThe highest price a buyer is currently willing to pay. When you sell with a market order, you sell at the bid.Read in glossary → - the highest price any buyer is currently willing to pay.
- Ask - the lowest price any seller is currently willing to accept.
- Spread - the gapGapA discontinuity on the chart - the open of one bar is meaningfully above or below the close of the prior bar.Read in glossary → between them.
- Depth - how many shares are stacked at each price level on each side.
When you click buy market, you cross the spread and take shares from the ask side - starting at the best (lowest) ask and walking up through the stack if your order is bigger than the top level. When you click sell market, you hit the bid side. Every trade is a transaction between one of each.
Mid = (Bid + Ask) ÷ 2
The 'fair' midpoint between the two sides. Quoted positions are usually marked to mid, not to your entry.
Spread = Ask − Bid
Spread % = (Spread ÷ Mid) × 100
Normalizes spread across different prices. 1 cent on a $520 stock (~0.002%) is radically different from 1 cent on a $2 stock (0.5%).
4. The spread is your real cost
A "commission-free" trade is not free. The moment you buy at the ask and sell at the bid, you pay the spread. On a round trip:
Cost = Spread × Shares × Round trips
One cent sounds negligible. Over hundreds of trades, it's not.
You trade 100 shares per trade, 10 round trips per day, 20 days a month = 200 round trips/month.
- Tight spread ($0.01): 200 × $0.01 × 100 = $200/mo → $2,400/year
- Medium spread ($0.05): 200 × $0.05 × 100 = $1,000/mo → $12,000/year
- Wide spread ($0.20): 200 × $0.20 × 100 = $4,000/mo → $48,000/year
Same strategy, same number of trades - the spread alone is the difference between an $8K/year edge evaporating or a $44K/year edge evaporating. Read the spread before you pick the instrument.
Typical spreads by instrument
| Instrument | Typical spread | Spread % of price |
|---|---|---|
| Mega-cap stock (AAPL, MSFT, SPY) | $0.01 | 0.002 - 0.005% |
| Mid-cap stock | $0.02 - $0.10 | 0.05 - 0.3% |
| Small-cap / low-volume | $0.05 - $0.50 | 0.5 - 5% |
| Penny stock | $0.01 - $0.20 | 1 - 20% |
| Major forex pair (EUR/USD) | 0.1 - 1 pipPipIn forex, the smallest standard price move. Typically 0.0001 for most pairs; 0.01 for JPY pairs.Read in glossary → | 0.001 - 0.01% |
| Minor forex pair | 1 - 5 pips | 0.05 - 0.3% |
| Major crypto spot (BTC/USD) | 0.01 - 0.05% | 0.01 - 0.05% |
| Small-cap crypto | 0.2 - 2% | 0.2 - 2% |
Rule of thumb: if your edge is smaller than 2× the spread per round trip, you don't have an edge - you have a slow way to donate to market makers.
5. Slippage - the spread's cousin
The spread is the cost for a small order (fits inside the top level). When your order is bigger than the resting size at the top of the book, you walk up (buying) or down (selling) the stack, getting progressively worse prices. That's slippage.
Slippage = Actual average fill price − Quoted best price at entry
For a market order, slippage is unavoidable on the part of your order that exceeds top-of-book size. Limit orders eliminate price slippage but introduce fill-risk slippage (you might not get filled).
You want to buy 5,000 shares. The ask side looks like:
- 1,620 @ $100.05
- 1,340 @ $100.10
- 1,100 @ $100.15
- 760 @ $100.20
- 480 @ $100.25
- 260 @ $100.30
A market orderMarket orderAn order to buy or sell immediately at whatever price is available. Guaranteed execution, not guaranteed price.Read in glossary → fills through every level until filled:
1620×100.05 + 1340×100.10 + 1100×100.15 + 760×100.20 + 480×100.25 + (remaining 700 at higher levels)
Weighted average fill: roughly $100.12 - 7 cents above the top-of-book $100.05. Your effective spread just widened 8× because your size ate the book.
Fix: break the order up, use a limit orderLimit orderAn order to buy or sell only at a specified price or better. Guaranteed price, not guaranteed execution.Read in glossary →, or pick a more liquid name.
6. When spreads are best - intraday volume profile
Spreads are tight when volume is deep and wide when it's thin. US equities volume follows a consistent U-shape (the "volume smileVolatility smileAn IV-vs-strike pattern in which both deep OTM puts and deep OTM calls trade at higher IVs than ATM. Common in FX and ahead of binary single-name events.Read in glossary →"): a spike at the open as overnight orders and news get absorbed, a drift into a midday low around lunch, and another spike into the close as day traders and algos unwind positions.
- Pre-market (4 AM - 9:30 AM ET) - thin liquidity, wide spreads, big gaps on news. Execute here only if you must.
- First hour (9:30 - 10:30) - highest volume, tightest spreads, most volatility. Great for scalpers; dangerous for beginners.
- Midday (11:30 - 1:30) - quietest. Spreads widen even on liquid names.
- Last hour (3:00 - 4:00) - volume ramp into the close. Position-squaring, index rebalancing, ETF creations.
- After-hours (4:00 - 8:00 PM) - earnings windows live here. Don't market-order in after-hours unless you enjoy pain.
7. Which drivers matter - depends on your timeframe
The four drivers don't carry equal weight for every trader. A scalper who holds positions for 90 seconds doesn't care about Q3 GDP. A long-term investor doesn't care that SPY's bid-ask just widened to 2 cents.
- Order flowOrder flowThe live stream of market orders hitting the book. Reveals who is aggressive (buying at ask, selling at bid) in real time.Read in glossary → & sentiment (top)
- News & events (top)
- Liquidity & spread (critical)
- Fundamentals (noise)
- Macro (relevant only on Fed days / CPI days)
- News & events (top)
- Sentiment (top)
- Technicals (entries and exits)
- Fundamentals (filter for what to trade)
- Macro (regime check)
- Fundamentals (top)
- Macro (top)
- Sentiment (contrarian at extremes)
- News (ignore daily, watch quarterly)
- Spread (irrelevant at this size / frequency)
- Current market regime (VIX level, rate expectations)
- Sector rotation (which drivers are dominant right now)
- Spreads on the instruments you actually trade
- Earnings + Fed calendar for your holdings
8. The pre-trade checklist
Before every trade, answer three questions - in this order:
- Who's buying, who's selling, why? Can you name at least one force (news, fundamentals, sentiment, macro) pushing the demand imbalance in the direction you're betting on?
- What could flip that balance against me? Earnings? A Fed surprise? A supportSupportA price level where buyers have historically stepped in with size. Acts as a floor until it breaks.Read in glossary → level breaking? Name the thing that would tell you you're wrong.
- Does my expected move cover the cost? Spread + slippage + commissions round-trip. If your strategy's edge is smaller, don't take the trade.
Most losing trades fail #1 and #2. Most winning strategies fail at #3 anyway because the trader didn't do the math.
Math cheatsheet
Mid = (Bid + Ask) ÷ 2
Spread = Ask − Bid
Spread % = (Spread ÷ Mid) × 100
Cost = Spread × Shares × Round trips
Slippage = Avg fill price − Quoted best price
Key takeaways
- Prices move for exactly one reason: imbalance between buyers and sellers. Every "reason" in the news is just a cause of that imbalance.
- Four drivers rewrite supply and demand: news, fundamentals, sentiment, macro. Different timeframes, different weights.
- Sentiment sounds fuzzy but has real numbers - VIX, put/call, advance/decline, AAII.
- The order book is supply and demand made concrete. You buy at the ask; you sell at the bid.
- The spread is a cost. A one-cent spread × 200 trades/month × 100 shares = $2,400/year per trader.
- When your order is bigger than the top-of-book size, you pay slippage on top of the spread.
- Intraday, spreads are tightest at open and close and widest at lunch. Trade when liquidity exists.
- Your timeframe determines which drivers matter. Pick one; don't try to watch them all.
Up next: trading styles and timeframes - how scalpers, day traders, swing traders, and investors express the same pre-trade checklistPre-trade checklistThe 5-item template (setup, invalidation, size, target, psych check) filled out before every entry. Kills most C-grade trades.Read in glossary → differently.
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