Price discovery is one of most basic economic principles. There is a point where the supply curve intersects the demand curve. This point is known as the value in which parties will exchange a good or service for a premium. The process of identifying this premium is known as “Price Discovery,” and is extremely relevant when trading on the futures market.
Using Modern Technology For Price Discovery
More than a century ago, the open outcry system was the means by which buyers and sellers discovered the price of an asset. The open-outcry auction system allowed buyers to bid against one another until there was a clear winner.
Conceptually, this process of price discovery was relevant because buyers would not bid more than they were willing to spin. Thus, the auction was the “Price Discovery,” and the sale price was where the supply and demand curves crossed. Buyers and sellers used the auction system for:
Now, although there are still traders on the floor of popular exchanges like the New York Stock Exchange, price discovery is significantly different because of technology. Technology now allows trades to occur in a matter of seconds, involving participants around the world. The technology was born out of necessity, as markets were growing in size.
But since then, technology has also made trading more accessible. For instance, in 2017, more than 25 billion contracts were exchanged on the global options and futures markets. Investors can now trade volumes larger than ever while also maintaining depth-of-market and liquidity.
What Is Order Flow?
Order flow is a term used commonly by investors in futures markets. It refers to the order in which buy and sell orders are placed in a market by active participants. Order flow is relevant to price discovery, especially in the digital marketplace, because it allows for real-time negotiation. Because of the digital market, traders can buy or sell orders instantly, which provides pinpoint price discovery.
For instance, order flow in the digital marketplace has resulted in tighter bid and ask spreads. Buyers and sellers are connected in real-time. However, the order flow could also result in more volatility, as a single transaction could cause a massive spike or dip. Although bid and ask spreads are tighter, the futures markets have also seen wider trading ranges. Experienced investors see this as an opportunity on which they can capitalize.
Lastly, order flow drives price discovery because of sustained supply and demand. When there is a steady order flow, there is substantial depth. There is never a shortage of buyers or sellers, which increases the likelihood of traders finding a desirable fill.
Learning More About The Futures Market
Futures serve as an excellent way to diversify your portfolio. While price discovery is straightforward in concept, it can prove challenging to comprehend in practice. Learning the nuances of price discovery, order flow, and other relevant topics could do wonders for your portfolio. Investors should make sure that they understand these topics before entering the futures market.
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Important Futures Trading Disclaimer
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Your broker may have a contractual agreement not to seek redress for slippage, it’s obligation to execute stop loss orders at the stop loss price or better, will not apply to limit and stop loss orders during hours when it is closed. This also does not include bad price spikes. Bad price spikes are removed from the price charts quickly to alleviate confusion.