Price Discovery

Reviewed by Bhavana | Updated on Aug 27, 2020

Meaning of Price Discovery

Price discovery is a process which determines market prices, mostly through interactions between buyers and sellers. Price discovery is a method for determining the spot price of a commodity through interactions between sellers and buyers – often referred to as a price discovery process or price discovery mechanism.

Typically, the balance between sellers and buyers is an essential predictor of a market's demand and supply; and demand and supply are major drivers of price changes. This balance is best seen when presenting support and resistance rates on a price line.

Resistance rates represent the point at which demand for a commodity has begun to fall, which is dragging down the price. Help means the point at which demand for a commodity starts to increase, which pushes the price up – both presuming that supply remains consistent.

How Does Price Discovery Function?

Price discovery allows sellers and buyers to set the market price of a tradable asset. That is because the price discovery mechanisms set out what sellers intend to acknowledge, and what buyers intend to pay. Therefore, price discovery is related to finding the equilibrium price, which facilitates the maximum liquidity for that asset.

Which Factors Determine Price Discovery?

There are various factors which decide the levels of price discovery. Following are a few factors:

  • Supply and demand
  • Attitudes to risk
  • Volatility
  • Available information
  • Market mechanisms

Why Is Price Discovery Important in Trading?

Price discovery matters in finance, as the driving factors behind the financial markets, are supply and demand. In markets that are continuously in a state of bullish and bearish flux, it is crucial to continually reassess whether a product, stock, forex pair, or index is currently under/overbought and whether its market price is fair to buyers and sellers alike.