What Is Price Discovery?

Price discovery is a process in which the supply and demand sides of the futures market openly bargain, and through fierce competition, the price level of a commodity is continuously updated and continuously spread to the world, so that the price of the commodity becomes a world price. Simply put, price discovery is the process of finding competitive prices and world prices. Price discovery is one of the important economic functions of the futures market. Different from the spot market decentralized transaction price formation, the futures market can form a relatively mature and excellent price mechanism, which is similar to a completely competitive market. Futures prices are the prices of buying and selling futures contracts formed by trading futures on the futures market, and futures trading is carried out in specialized futures exchanges. According to the provisions of futures trading, the purchase and sale of all contracts must be conducted through open outcry in the trading floor of the futures exchange. Private trading is not allowed. This allows all futures contract purchases and sales to be achieved through competition. The market became an open and freely competitive market. The resulting futures price can more accurately reflect the real supply and demand situation and its changing trend. Competitive price information of futures markets around the world is continuously spread to the world and affects each other, thus forming a worldwide competitive price. ^[1]

Price discovery

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Price discovery is a process in which the supply and demand sides of the futures market openly bargain, and through fierce competition, the price level of a commodity is continuously updated and continuously spread to the world, so that the price of the commodity becomes a world price. Simply put, price discovery is the process of finding competitive prices and world prices. Price discovery is one of the important economic functions of the futures market. Different from the spot market decentralized transaction price formation, the futures market can form a relatively mature and excellent price mechanism, which is similar to a completely competitive market. Futures prices are the prices of buying and selling futures contracts formed by trading futures on the futures market, and futures trading is carried out in specialized futures exchanges. According to the provisions of futures trading, the purchase and sale of all contracts must be conducted through open outcry in the trading floor of the futures exchange. Private trading is not allowed. This allows all futures contract purchases and sales to be achieved through competition. The market became an open and freely competitive market. The resulting futures price can more accurately reflect the real supply and demand situation and its changing trend. Competitive price information of futures markets around the world is continuously spread to the world and affects each other, thus forming a worldwide competitive price. ^[1]

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1.Principle

Price discovery is a major function of the stock index futures market, that is, the futures market has the ability to provide information on the price of the underlying asset. The stock index futures price reflects investors' expectations of the stock index at a certain point in the future. Because of the low required margin and cheap transaction fees, the liquidity is excellent. Once there is information that affects investors' expectations of the market, it will be quickly reflected in the futures market and can be passed to the spot market, so that the spot market price reaches equilibrium. The stock index futures market actually reflects investors' information or expectations of future stock index trends into futures prices through low-cost, high-liquidity transactions.

2. Lag

The lag time for transmitting information from the futures market to the spot market is divided into long-term and short-term, which is related to the type of information and investors' expectations or judgments based on the information. For example, when clear and clear information (such as interest rate hikes, stamp duty adjustments, etc.) appears, the lag time passed from the futures market to the spot market is short, and even the two markets react almost simultaneously; Expectations on regulatory policies, changes in the macroeconomic situation, etc.), the lag time for transmission may be longer.

For small and medium investors, the price discovery mechanism of stock index futures for clear information cannot be transformed into an actual operating strategy for investors, because compared with funds and institutional investors, small and medium investors are in Disadvantage. In contrast, small and medium investors can easily use the stock index futures to operate the price discovery mechanism of fuzzy information. Due to the leverage of futures market trading, compared with the spot market, the futures market is more sensitive to information. When fuzzy information appears, it will also respond in a timely manner.