Unveiling forex indicators explained pdf Secrets – How is the Price Formed? It is only natural that price formation process is interesting for just about anybody.
And it is not important whether you want to buy potatoes or shares of an oil company – the matter of prices is always relevant, especially for those working in financial markets. And if you have any questions regarding why and how the prices change and form you will find the answers in this article. Price formation is one of the key elements of market economy functioning. The price of a commodity or a service is formed as a result of numerous economic, political and social processes and this is true for traditional commodity relations as well as for financial markets. We commonly distinguish between two major aspects of price formation: centralized and market ones.
In the context of stock and currency markets the market price formation based on the principle of demand and supply is considered a priority. In other words the price of a currency or a security constitutes a sum that a buyer is willing to pay for it. However, elements of centralized price formation are not alien to financial markets, since large participants of economic relations can influence the price of trading instruments much more than the demand of private investors. For example, actions of central banks such as currency interventions, liquidity increase or key interest rate decrease have a great influence on Forex instruments’ price formation. One of the main theories of price formation is based on the fact that each commodity has its price reflected by an abstract labor spent on its creation. But economic analysis of price formation in financial markets is complicated by the fact that it is impossible to calculate the expenditure cost for a currency or a security. Whereas for traditional commodity relations between a buyer and a seller the expenditure cost concept is applicable and rather convenient, it is, in essence, useless for financial markets.
A seller of a particular material commodity can calculate how much abstract labor was spent on its production but in regard to securities and currencies this method does not work. But on the whole, the other concept is in effect in financial markets – monetary basis of the price which presumes the price formation under the influence of demand and supply mechanisms. In the context of stock market and the foreign exchange market this concept is more relevant since it shows the dependency of price on buyer’s subjective evaluation and determines the price as a result of a standoff by two sides – sellers and buyers. In order to understand the price formation mechanisms in financial markets we need to understand who is taking part in the trading process. The stock market is mostly represented by emitters that in this context are closer to sellers, and investors.
An emitter is an organization that issued its securities to the market and an investor is an individual or a corporation acquiring these securities, as a rule with the aim of their subsequent resale. The major currency exchange participants are central banks, hedge funds, brokers and other intermediary organizations, as well as private investors. I consider an important moment in comprehending the price formation mechanism in the currency exchange market to be the understanding that each Forex participant can switch from buyer’s position to seller’s one and back at any time. That is why we cannot talk about contrary interests of a buyer and seller in the context of FX market. In its turn the stock market presupposes a higher objectivity in price formation, since the main price elements are set by emitters before the securities are issued and released onto the market and become available to investors. If we are talking about the initial market, then the emitter makes a decision regarding the initial offering price, redemption price and, as a rule, date of redemption. As I said before, in this case the emitter includes the emission costs into the price.