Overview of Forex Price Discovery
Price Discovery is also often referred to as price formation, which is the process of determining the price in a market through the interaction between the seller and the buyer. Futures markets provide all important information and functions in price formation. Someone who has important information and good judgment enters this market (futures) to take advantage of the information it has.
When there is new information, such as good news about the economy, there will be action from speculators utilizing this information to the derivative market (futures) that will cause a change or price movement. Futures markets are usually the first to react due to reasonably low transaction costs compared to the spot market. So this makes the futures market as a market that gives an indication of what is happening in the market. Also very helpful in the establishment of a better price.
Dynamic markets such as the forex market, discovery / price formation takes place continuously when there is a certain buying and selling pair. Prices sometimes fall below the average (excess supply) and can also be above average (excess demand) due to uncertainty. Changes to such offers are due to buying and selling: trading.
The process of price formation involves the seller and the buyer present at the transaction price (running) a certain asset (pair) for a certain period of time as well. Covers, sellers and buyers, market mechanisms, available information and risk management undertaken. This price formation process is also sensitive to the following factors:
- Number of Buyers
- Number of Sellers
- The number of assets traded over a certain period
- The current volume of the transaction
- Bid and Offer prices during a transaction
- Funds involved during the transaction
- Transaction Fees
- Availability of information and Transparency
It’s a natural law if many buyers (demand / demand) will drive prices up, and many sellers (supply) will drive prices down. But in the forex market, sellers and buyers do not communicate directly. They only see the price display electronically between Bid and Ask or selling price and purchase price. Also the above factors will influence their actions.