On the Nature of Price Movement

There are, I think it is safe to tentatively assert, only two reasons why the prices of things – whether goods, services, financial instruments, derivatives or other commodities – fluctuate.  These can be categorized as flow and state.  Consider first the notion of flow.  At the margin where price determinations are made, there are usually a bid and an offer price.  Now in everyday life these may not exist, as at a store like Target where you simply take whatever price is marked.  You are a price taker and the store is the price maker.   But even in many store based commercial transactions you may haggle with the store owner and make an offer of payment (bid) while the proprietor may alternatively suggest a usually higher asking price (offer or ask, I know the terminology becomes confusing as the word offer is used on both sides with slightly different denotations or connotations).  One side or the other will become the aggressor.  Prices tick down when the offeror hits the bid, and conversely tick up when the bidder takes the offer (argh the terminology, damn and praise the indeterminacy of language).

When there is a preponderance of bidders hitting the offer price then the price of whatever is being priced tends to trend higher.  When there is a preponderance of sellers hitting the bid, then the price will trend down.  Flows can therefore exert powerful price effects and by watching the price move, as in financial markets, one can tell whether there are more buyers or sellers on balance, or more precisely, whether the buyers or sellers are more aggressive, whether buyers or sellers are in control of price setting at the margin.

Now consider the idea of state, or more importantly state change.  It may come to pass, for instance, that a meteorological service comes out with a report that predicts imminent drought in the flyover country that is a true sine qua non of our nations vast wealth.  Whether markets are open or not, there will be a discontinuity in price.  Offers at the prior prevailing level of prices will be pulled or filled as participants reevaluate what makes sense for prices.  This also occurs in either direction on the first Friday of each month when the employment figures are released in the US.  Flows will surge to one side or the other in response to the new information.  Flows can be thought of as intrinsic to the idea of the marketplace while state can be thought of as extrinsic.  Of course perceptions about change in state will cause changes in flows.  And reflexively in the Soros sense, flows can lead to general perceptions about state as well.

One can argue that perhaps it is flows after all that move everything, they just move quickly in response to new information.  I kind of think of that like arguing about whether the number zero exists.  Since it denotes the idea of nothing then ontologically it could be said not to exist.  But I think there is enough of a difference to separate into two concepts.  And anyway it does not really matter as much as being observant about what flows are doing and being on the lookout for changes of state that could change perceptions in a flash.

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