But on the whole, the other concept is in effect in financial markets – monetary basis of the price which presumes the price formation under the influence of demand and supply mechanisms. In the context of stock market and the foreign exchange market this concept is more relevant since it shows the dependency of price on buyer’s subjective evaluation and determines the price as a result of a standoff by two sides – sellers and buyers.

In order to understand the price formation mechanisms in financial markets we need to understand who is taking part in the trading process. The stock market is mostly represented by emitters that in this context are closer to sellers, and investors. An emitter is an organization that issued its securities to the market and an investor is an individual or a corporation acquiring these securities, as a rule with the aim of their subsequent resale. Moreover, investment companies and funds also take part in stock market instruments’ price formation.

The major currency exchange participants are central banks, hedge funds, brokers and other intermediary organizations, as well as private investors. I consider an important moment in comprehending the price formation mechanism in the currency exchange market to be the understanding that each Forex participant can switch from buyer’s position to seller’s one and back at any time. That is why we cannot talk about contrary interests of a buyer and seller in the context of FX market. An important role is played by objective factors as well as subjective evaluation of a currency by market participants, their fears and expectations. Frequently, an asset may be overestimated or underestimated due to some psychological factors and price fluctuations are a result of aggregate opinion of market participants which influences the demand curve.

In its turn the stock market presupposes a higher objectivity in price formation, since the main price elements are set by emitters before the securities are issued and released onto the market and become available to investors. If we are talking about the initial market, then the emitter makes a decision regarding the initial offering price, redemption price and, as a rule, date of redemption. As I said before, in this case the emitter includes the emission costs into the price. In the initial market the price formation opportunities are rather limited unlike the secondary market which is unlimited in space and subsequently allows the securities’ prices to form in accordance with market factors – supply and demand.

On the one hand it is essential for a constant supply of various securities to be in the stock market, and on the other hand there must be an active demand for them. The balance of supply and demand forms the real asset price, but it is often the case when the price is overestimated because of unsatisfied demand or underestimated because of excessive supply. Competition also plays its role in price formation in the stock market – thus, for example, if a monopoly is developing in the market, then it forms a decreasing tendency for the emitter’s securities.

Objective Factors of Price Formation in Forex

As I noted before, the price formation in the currency exchange is influenced by objective and subjective factors. The subjective ones include political, economic and social factors, namely the interest rate, volume of gold reserve which is a guarantee of the currency’s stability, indicators of GDP, industrial and business activity, internal and external demand, employment and inflation. As a rule, traders also pay attention to stock indices (e.g. DAX 30 for Germany or Dow Jones for the US) since their growth indicates the price increase of the country’s leading companies’ shares, and their fall means the decrease of the share prices.

There is also a concept of force-majeure. It can be regarded as both, objective and subjective price formation factor. In case of political or ecological force-majeure foreign investors begin withdrawing their assets from the country which weakens the national currency. But often the reason for rapid price fluctuations is not the negative consequences themselves but market participants’ expectations.

The Role of Subjective Factors in Price Formation

Recently we can see the role of expectations in the currency exchange growing. The decisions on buying and selling are made by investors on the basis of the future price forecasts which, in essence, play the role of “self-fulfilling prophecies” since the traders support their forecasts with their actions using substantial borrowed funds. With margin trading used by traders to increase the invested funds the aggregate influence of private investors on the price of a trading instrument has increased significantly.

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