How are price formed in the Stock and Forex markets?

trading systems forex stock price formation

It is only natural that price formation process is interesting for just about anybody. And it is not important whether you want to buy potatoes or shares of an oil company – the matter of prices is always relevant, especially for those working in financial markets. And if you have any questions regarding why and how the prices change and form you will find the answers in this article. Well, let us begin!

Price formation is one of the key elements of market economy functioning. The price of a commodity or a service is formed as a result of numerous economic, political and social processes and this is true for traditional commodity relations as well as for financial markets.

Centralized and Market Aspects of Price Formation

We commonly distinguish between two major aspects of price formation: centralized and market ones.

In the context of stock and currency markets the market price formation based on the principle of demand and supply is considered a priority. In other words the price of a currency or a security constitutes a sum that a buyer is willing to pay for it.

However, elements of centralized price formation are not alien to financial markets, since large participants of economic relations can influence the price of trading instruments much more than the demand of private investors. For example, actions of central banks such as currency interventions, liquidity increase or key interest rate decrease have a great influence on Forex instruments’ price formation. And the stock market depends on decisions of emitters that issued the securities, initial price, goals and price formation strategy.

The Concepts of Expenditure Cost and Monetary Basis of the Price

One of the main theories of price formation is based on the fact that each commodity has its price reflected by an abstract labor spent on its creation. But economic analysis of price formation in financial markets is complicated by the fact that it is impossible to calculate the expenditure cost for a currency or a security.

Whereas for traditional commodity relations between a buyer and a seller the expenditure cost concept is applicable and rather convenient, it is, in essence, useless for financial markets. A seller of a particular material commodity can calculate how much abstract labor was spent on its production but in regard to securities and currencies this method does not work. Though I think there is one exception to this rule – a calculation of a share’s initial cost to which the emitter includes the cost of issuing and registration.