My point is simply a tautology: the price is the price. Now the price may change, someone may have their thumb on the scale, there may be shill bidders driving sentiment, etc. But at the moment you get a bid/ask spread, that is what you get.
Practically speaking, I personally don't believe the efficient market hypothesis due to the very obvious meddling by political actors, central banks, national treasuries, etc. Behavioral finance has also consistently demonstrated that humans do not react rationally in markets.
I'm not talking about the bid-ask spread. A bid is just someone willing to buy something for a specific price. An ask is someone willing to sell something at a specific price. The bid-ask spread is the difference between the lowest ask and the highest bid.
The point I am making is that the order books of markets don't accurately reflect the real underlying demand for the securities.
Let's take a hedge fund, who would buy apple at $5. It's incredibly unlikely that they will actually place a bid on the order book at $5 for apple. Instead, they will monitor the price of apple and buy it if they see a good price.
The value that human traders can provide is that they can tap into this hidden sources of liquidity that isn't reflected on the order book of the exchange. They can call up some manager and say "hey I can sell you something at a good price, you interested?"
Without human traders, there is no way to tap into this liquidity. This occasionally causes problems in thinly traded markets or during after-hours trading.
Yours was the comment that made me understand how the spread economics described elsewhere in this thread worked, thanks for that. The average price increase in the absence of the HFT bids was the part that made it click.
A perfectly efficient market will push the bids higher and the asks lower. Stocks for example only have a spread of a couple of pennies.
As the markets get less and less efficient, you become more reliant on middle-men to perform transactions. In the dark ages, people would pay 1-pound of gold for 1-pound of salt. In the case of modern society: bonds (and other derivatives) are less efficient to trade and therefore have higher bid/ask spreads than stocks.
Go away from financial instruments, and a 30% spread on bid/ask is actually reasonable. Play Magic: The Gathering? Buying/selling used video games? You're going to pay a pretty large spread.
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"Fair Market Value" is an estimation of the bid/ask spread. There really are two fair prices: the value the buyer is willing to pay, and the value the seller is willing to sell at. These two numbers are all that matters.
By definition, these two prices are fair. Because if they weren't fair, then the buyer (and seller) would reject the deal and the trade will fail.
A current price aka price at last trade of 10$ and nobody willing to sell for less than 10$ and nobody willing to buy for more than 9.99$.
A new seller shows up, if they are willing to wait they might get more than 9.99$ or they can accept 9.99$.
Or a new buyer shows up they can buy for 10$ or wait for a lower price.
Now, without effort people can just look at the history of trades and see the price rise or fall. This is independent of whatever reason that causes more people to suddenly want to buy or sell, just the fact that people are buying or selling in it's self moves the price.
What we choose to value as society is entirely subjective. While supply and demand influence the change in the mid point of the bid/ask spread - it doesn’t set the absolute clearing price.
If what happens in the article is correct, it is very similar to what auto-bidding shill bots do on auction sites, eBay, they obtain information on the highest price you were willing to pay for an item.
Is this the price we(investors) are willing to pay for 0.03sec liquidity? I am not sure it is worth it.
That's a perfectly fine definition, but the post I was relying to was not taking that into account. It was suggesting that in a perfect market the possibility that maybe a certain course of action might be followed, that this must be priced in. If you follow that logic, then in perfect markets prices should never change. The problem is it's flawed logic because uncertainties cannot be priced in.
If they believed this, they wouldn't be selling at the current spot, sellers would all be putting their asks ~46% above spot (discounting time value of money), and the market would move.
That risk and upside is already priced in if you believe in market efficiency.
My suspicion (which I can't prove--this is just a gut feeling) is that there is an economically correct price for any given thing, and that markets will move toward that price. This economically correct price only changes when factors in the "real world" change, or we have reason to believe factors in the real world are going to change (e.g., bad weather might reduce crop yield, or forecasts of bad weather make is expect a reduction in yield).
Actors in the markets get information not only from real world sources (e.g., news reports), but also infer information from the activity of other actors in the market, so there is a bit of a feedback look in the market.
My suspicion is that as you increase the frequency of trades, starting from very infrequent (e.g., people trading in person directly with the person they are buying or selling from) and then going to faster and faster methods (trades by mail, then telegraph, and so on), there are two effects. First, the market is able to more quickly converge to near the "correct" price for the item, and there is some increase in fluctuation around the correct price due to strengthening of the feedback loops.
I suspect that there is some optimum trading speed, which depends on the rate that the real world events (things like weather changes, fashion, wars, and so on) happen, and when you push trading speed past that you stop gaining on convergence speed, but continue increasing instability due to the feedback loops.
The result is a market that is less and less tied to the real world. In effect, the market ends up makingup information from the trading activity itself. The trading essentially ends up being based on noise rather than signal. It's hard to see how that can be good.
I can see your interpretation, but I think the way he has it also makes sense. The buy price is what people are willing to buy it for (i.e. it's the bid). The sell price is what people are willing to sell it for (i.e. it's the ask).
Perhaps switching to bid/ask would be a good idea to clear up the confusion, but it's potentially more confusing to people unfamiliar with financial markets.
There's a bit of a feedback mechanism, since the only price that really matters is the one you can get. If you had an auction (the stock market is already an auction that's always ongoing, btw) as soon as its revealed that Warren Buffet bid X, you'll see people bid X+1, even if 30 seconds earlier they had scoffed that X was totally unrealistic. You could have a silent auction, but the facts come out eventually, and then you'll see the same eruption of trading. That's almost what the bankers are doing behind the scenes, holding a private silent auction.
It's important to note that the EMH doesn't suppose that all actors agree on the price. It just means that the price represents the summed outlook of participants.
Those who think a stock is underpriced will bid it up to get more; those who think it is overpriced will sell out at progressively lowering prices.
Because the movement in prices creates an opportunity to profit for those who have information that is not yet revealed, those people will enter the market and create pressure on the price.
In some mathematical forms, this is assumed to happen instantaneously and universally. Thus: all available information is factored into the price. Essentially, you can't arbitrage because you have instantaneously driven up the price already by arbitraging. (It's weird, yay calculus).
The looser forms basically say that this is what happens in the long run, on the average, even without instantaneous adjustment of prices. And when you compare market time series to pure randomness, they have similar characteristics. So in a sufficiently large group of agents, some will profit and some will lose merely by chance. Then you're back to taking an average and being unable to beat it in the long run, because in a game of chance outcomes converge to the long-run probabilities of the game.
It's more like, everybody who has a view on the value of a security can put some money where his mouth is. The price will move accordingly, until nobody who has a different opinion has any money left to put behind it.
If smaller differences between current price and opinions can lead to action--because of lower transaction costs--the market is better.
"The faster the price discovery, the shorter the validity time. This means a more accurate price."
A continuous market price is an illusion; let's not forget that. Every market is made up of trades, which are discrete, and every price has an unstated amount of uncertainty, which may be large by any standards. You can't know from first principles whether a change in quoted price is even a change in the market, because it could be within the +/- range that's implicit. Apple is quoted to the nearest penny, at least, but the idea that the current price is accurate to within 0.004% is ridiculous.
Edit:
"Fischer Black famously defined an efficient market as “one in which price is within a factor of 2 of value, i.e., the price is more than half of value and less than twice value,”
...I hadn't heard this before Matt Levine mentioned it, but I was like "yeah, obviously, why haven't most people gotten the message?"
But:
"BNP Paribas...said [Saudi] Aramco was worth exactly $1.424394 trillion."
I wonder which particular millisecond that held for.
Edit Edit:
The market has a whole (mostly) unseen dimension other than uncertainty, which is depth. You can only buy or sell so many shares at the instantaneous market price. Further away, there may be orders, but the price of the whole company is going to be way outside of that. The shorter the timescale, the shallower the "market" so you can't just say we're making progress by doing things faster. It's like when research lasers are said to make unbelievable power, but it's like for a femtosecond or something. Liquidity, in my mind, requires depth, just as with water.
I'm not sure what you're saying, but the spread between buying price and selling price is exactly how the temporary middle man gets paid for the risk they take in matching up buyers and sellers. The size of the spread depends on how large the perception of that risk is.
Practically speaking, I personally don't believe the efficient market hypothesis due to the very obvious meddling by political actors, central banks, national treasuries, etc. Behavioral finance has also consistently demonstrated that humans do not react rationally in markets.
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