Price Discovery

Nobody sets the price of a listed asset. The price emerges from the flow of orders, each carrying a fragment of information or need, and the process by which trading turns dispersed private information into a public number is called price discovery. It is one of the two services a market provides, alongside liquidity, and the tension between the two organises much of market structure.

Prices aggregate information

Every trader acts on something: research, a model, a hedging need, a cash flow. When a participant who believes an asset is underpriced buys it, their buying pressure nudges the price up, moving it toward their estimate and revealing a blurred version of their information to everyone watching. The market price at any moment is a running aggregate of all such actions: not anyone's opinion, but the level at which current buying and selling interest balances.

The aggregation can be remarkably effective because errors partially cancel: participants too optimistic and too pessimistic offset, and the price centres near the information-weighted consensus, the same variance-reduction arithmetic as averaging independent estimates. It is not magic, and it fails in identifiable ways: when information is one-sided, when participants imitate each other rather than acting independently, or when the flow is dominated by trades made for reasons unrelated to value.

How information gets in

Information enters prices through two channels. Public announcements move quotes directly: when scheduled data is released, quoted prices jump before almost any trades occur, because everyone updates simultaneously and quoters move their prices rather than waiting to be traded with. Private information enters through order flow: an informed trader must trade to profit, their trading pressure is visible even when their identity and reasoning are not, and other participants adjust prices in response. The second channel is slower, noisier, and central to the economics of market making, where it reappears as adverse selection.

Efficiency, in degrees

The efficient markets hypothesis states that prices reflect available information, conventionally in three grades: weak form (past prices are fully reflected, so patterns in price history alone carry no profit), semi-strong form (all public information is reflected), and strong form (private information too). The hypothesis is best treated as a benchmark rather than a verdict: markets are efficient enough that easy profits are rare, and inefficient enough that the participants who correct prices are compensated for the work. That tension is not a paradox but an equilibrium: prices are informative BECAUSE someone profits from making them so.