.. Price Discovery

So price discovery process finally results in a price at which trade happens. This price point in isolation tells us almost nothing about the market. After all one entity tells us nothing unless we have something to compare it with. The comparison could be a price for the same underlying at some time in the past. This tells us, supposedly, whether the market is trending up or down or going no where!

But as we repeatedly say, these are simplistic assumptions. Reality is quite different. Any way how to make sense of this is for another topic and another day. What we would like to stick to here is how the price discovery happens.

Price discovery is different from valuation (which is determination of economic value of an asset or liability) .

Price discovery process involves buyers and sellers arriving at a transaction price for a specific item at a given time. It involves the following:

• • Buyers and seller - their number, power and valuation perceptions

  • Market mechanism - bidding and settlement process, liquidity, market size

  • Available information - projections, market information and reliability of it

  • Risk management choices in terms of hedging, speculation

Thus multiple factors and perception of such factors by a multitude of players decides the price at a point of time. In many ways market brings all these complexities together and provides a simple result to us to work on - price.

In fact price discovery, demand, supply all impact on one another and have complex and non linear relationships. Thus millions of participants make a complex equation in to a simple number. To derive these equations today's best computers will prove inadequate.

In fact this price discovery process is the prime reason why market economies plan their resources better than planned economies. Individuals may find the equations mind boggling but as a mass, as a natural process they get solved! Some thing that the politicians/economists in planned economies can not do.