The marketplace’s job is to make it easier for people to buy and sell things. Price will keep going up and down as it tries to find a place where trade can happen easily. If the price is too low when the auction starts, it will go up to find sellers. On the other hand, if the price is too high when the auction starts, it will go down to find buyers. If you put this information into a framework that is easy to understand, you will see that it all makes sense. This auction process in stock market whole share bazar universe.
What is Auction Process in Stock Market?
If an original Maqbool Fida Husain painting went up for auction with a starting bid of Rs 1000, many people would buy it because the price is too low. Buyers would bid up the price until there was only one bid left. The auction would end with the sale, which would likely be for tens of thousands of crores. But what would happen if I put a handicraft by my son made when he was five year old up for auction with a starting bid of Rs 10 Lakhs?
Obviously, the starting bid is too high, so the price would start to go down until someone bought it. Price would eventually go low enough in the auction to find a buyer. May be his loving maternal aunt buys it for just Rs 1000. Price keeps going up and down so that both buyers and sellers can get the best deal. When they think the price is right, buyers will enter the market below what it’s worth. While sellers will jump in when they think the price is too high. This will be a theme that drives the stock market. I don’t understand how a first-time trader can be a smart shopper in a regular store but a totally different person when he or she is in the stock or futures market.
More about the Auction Market
Meet Novice Rahul, who is a great shopper when it comes to food, clothes, and even cars. But when it comes to trading, he goes against everything he knows. Rahul loves to eat Hilsa Fish, but he knows it can be pricey. So he only buys it when the price is below value. He keeps a close eye on how much Hilsa Fish costs and knows that, on average, one Kg costs about Rs 5000. As you might expect, when the price per Kg drops to Rs 2000, he buys several Kgs at once.
But the next morning, Rahul does something completely different on the stock or futures market. Instead of waiting for value, like he did with the Hilsa Fish, he quickly pulls the trigger at the worst times. He buys when the market is overvalued and sells when the market is undervalued. Basically, the way he trades would mean that he would buy Hilsa Fish for Rs 5000 per Kg, which is something he would never do. The idea of value is easy to understand, but using it consistently on the market takes experience. This can only be gained by studying and practicing a lot.
Working of Auction Process in Stock Market
Sometimes the price needs to go up before buyers and sellers can agree on a price. And sometimes the price needs to go down before buyers and sellers can agree on a price. Imagine a local cake baker who just opened her shop and is in the process of figuring out what her prices will be. Rina, the owner of Just Baked Cakes, doesn’t know how much her cakes are worth on the market. So, she puts them up for sale at Rs 100 each at first.
The large number of orders she gets shows that the market thinks this price is too low. Rina is very happy that she sold 1000 cakes in her first week. She does, however, decide to price it at Rs 200 to see what the market will do. She is happy to see that her orders have stayed at 1000 cakes per week. That means that people still think her cakes are a good deal at the price they are now.
She decides that she needs to go even higher to make the most money. So she raises the price of each cake to Rs 300. This time, though, the market didn’t respond as well. She only got 500 orders to buy. She quickly puts back the Rs 200 price tag and is happy that she has helped both the buyer and the seller in a fair way. If you understand this example you already understood the auction process in stock market.
The example above gives a clear picture of why prices will rise through resistance and then drop sharply, or fall through support and then rise strongly. The market must sometimes break down to go up and break out to go down. The market is always looking for the best place to make trade easy, and it usually needs confirmation at an extreme before it can keep going. To learn more about how an auction works, we need to understand the people who take part in it: ie, buyers and sellers.
If we understand the auction process in stock market well we can use it in trading. Trading systems like Order Flow Analysis or Market Profile is built into the concept.