Price discovery is a process for determining an appropriate price for an asset, security, commodity to currency. Price discovery occurs when sellers and buyers interact with each other to bid prices in a regulated capital market using a centralized system or in a forex market that uses a decentralized system and forms spot prices. In other words, price discovery is a journey from the process of bidding on prices until finally an equilibrium point is found, which is the price we see on the online trading terminal.
With the rapid development of information technology driven by faster internet access, transactions in the capital market and futures market take place efficiently. Any party who wants to sell and buy assets or securities can make transactions easily and in a short time. Only by “clicking” buy or sell, the transaction will be forwarded by the broker to the market to be completed.
If the number of buy transactions is more than the sell transactions, the price rises and when the number of sell transactions is greater than the buy transactions, the price decreases. This is in accordance with the law of demand and supply which is popular in English as the Supply and Demand Law. The Bid and Ask prices change dynamically every second according to the ever-changing number of requests and offers, then the latest prices are spread all over the world instantly.
Basically, the determination of prices for goods and services in the market uses a system similar to an auction process. There are sellers who offer goods or services at a certain price and buyers who are interested in buying at a lower price. There is a price bargaining process which is the core of price discovery until a price is reached that is deemed appropriate by both parties.
When we find prices fluctuating, the cause is the change in the number of requests and offers compared to before. There are various situations that make supply and demand change, such as changes in global economic conditions, changes in the international geopolitical situation, issuance of new policies from the government to shifts in the domestic political arena.
A condition can make the amount of supply greater than the amount of demand and prices fall. In other conditions, the amount of demand is greater than the amount of supply and makes the price rise. This process will always be passed in price discovery until a balance is found between the two. The price formed by this mechanism has filtered various available information and in the end it becomes the bid and ask price that we see in the online trading terminal. Because prices always fluctuate every second, it means that there is a change in the number of requests and offers every second.
Example I:
In 2021 the President of the United States decided to launch an economic stimulus of 2 trillion US Dollars to support the economy due to the pandemic. There are many people who finally have the money to spend and keep the economy going as it did before. Traders and investors finally understood that the US economy would recover faster than the UK and European Union economies. The number of requests for the USD also increased beyond the number of offers and the demand for EUR and GBP fell so that the EURUSD and GBPUSD pairs tended to form a bearish trend.
Example II:
Since the last few years leaders in the European Union region have rejected the existence of CPO which is Indonesia’s main export commodity. Until finally a policy was made to refuse imports of CPO products to every country in the European Union. The impact was a decrease in demand for CPO and a relatively stable supply, which triggered a decline in CPO prices on the international market.
From the two examples above, we can see the behind-the-scenes process that caused the EURUSD and GBPUSD bearish prices and the CPO price to fall. The whole process is price discovery. However, because prices must be determined every second, the price discovery process always takes place every second to determine the most appropriate price every second.
In general, the balance between buyers and sellers is an effective indicator as well as a predictor for analyzing the level of demand and supply formed in the market, and the level of demand and supply is the main factor driving price changes in the market. To get the price balance point, the best way to use is to look at the support and resistance levels on the price chart. The support or support level is the starting point or starting point where the price of an asset or security is pushed higher due to an increase in the level of demand (demand) assuming that the supply level is fixed. Meanwhile, the resistance level is the starting point for the price of an asset or security to decrease due to reduced demand in the market, assuming that supply is constant or abundant.
From these support and resistance levels, an analyst or trader can clearly read the dominance that is taking place in the market for a certain period of time, whether it is dominated by buyers or sellers. When market dominance is in the hands of buyers or buyers, it can be seen clearly that prices will be encouraged to continue to rise up to a certain price level where no one is willing to buy anymore. Likewise, when market dominance is in the hands of the seller or sellers, it can be seen clearly that the price will be pressured to continue to fall until it reaches a certain price level where no one is willing to sell anymore. Information on the dominance of buyers or sellers is of course important, so that analysts or traders can measure the price discovery area effectively, where there is a balance between demand and supply for the observed asset or security, so that they can determine the market price or spot point of the asset or security being traded.
The factors that determine price discovery include:
* Requests and Offers
Demand can be created when there is a desire to buy assets or securities accompanied by the ability to pay for them. In simple terms, it can be said that demand is a desire, desire, or willingness that is accompanied by the ability to be able to buy assets or securities at a certain price level and time. While supply is the number of assets or securities that can be offered by sellers to buyers at each price level during a certain period of time. The number of bids will largely depend on the high or low price of the asset or security. If the price of an asset or security rises, the number of assets or securities offered will increase, and conversely if the price falls, the number of assets or securities offered will also decrease.
* Risk assessment
The agreement that occurs between the buyer and the seller will be greatly influenced by how the buyer and seller evaluate the risks that may occur in the future. The greater the opportunity for profit, of course it will be proportional to the amount of risk that can occur. When a trader is willing to take the risk of buying an asset or security that is experiencing a decline in price or is technically discounted to gain the potential benefit from a large increase in price, then the trader may be willing to buy more to secure his exposure in the market, and this risk can be calculated using the ratio of reward to risk, and for both buyers and sellers, it is important to maintain that the level of risk that occurs is acceptable by using the limits determined according to their respective trading styles.
* Volatility
Volatility is a measure or level of fluctuation in asset or security prices that occur from time to time which indicates the level of risk associated with changes in asset or security prices. A price analyst or trader can calculate the volatility of an asset or security to assess and determine past price variations to predict future price movements, and this becomes a determining factor in whether a trader will open or close their position in the asset or security being traded. High volatility is believed to offer large profit opportunities, but at the same time, the risks that will be faced and borne are also large.
* Available data and information
Available data and information that can be accessed by buyers and sellers also determines whether they are willing to buy or sell these assets or securities. For example, the release of interest rates by the central bank which is eagerly awaited by market participants, will certainly influence whether buyers are willing to buy or not after the value is known clearly. When the sentiment is positive, of course, it will invite more buyers to enter and push the price up, conversely if the sentiment is negative, then of course the buyer will refrain from buying the asset or security.
