Price DiscoveryWHAT IT IS:Price discovery refers to the act of determining the proper price of a security,
commodity, or good or service by studying
market supply and demand and other
factors associated with transactions.
HOW IT WORKS (EXAMPLE):In a simple sense, price discovery involves finding where supply and demand meet. As you may recall from
Economics 101, the
market price is the price at that intersection of supply and demand.
Though
analysts and
economists work hard to determine the exact shapes and locations of demand and supply curves, in reality it's virtually impossible to know these things with certainty. (This is also why so much research attempts to explain what exactly causes securities prices to change.) Nevertheless, the interaction of supply and demand lies at the heart of price discovery.
However, proper price discovery also depends on the number, size, location, and competitiveness of buyers and sellers, as well as the behavior of the buyers and sellers. The amount,
timeliness, and reliability of
market information and price reporting are also crucial. In turn, individual transaction prices reflect a number of
factors, but they usually revolve around a general market price at any given point in time.
WHY IT MATTERS:Price discovery is what gets a specific buyer and specific seller to move from a establishing a general price to agreeing on a specific price for their transaction, based on the size of the transaction, location of the transaction, cost of the transaction, and many other
factors. It is a dynamic process, and in a way, it is the true mission of any
market and any exchange.
