- Yair Mark
I spent the day today getting a more in-depth understanding of how the financial system works on the financial markets training I attended. The training gave a very good overview of many of the key aspects of financial markets in a short period of time.
Automatic Price Correction
What was fascinating is how prices are derived. In a truly free market the price is purely dictated by supply and demand. Essentially buyers offer a price and if sellers are happy with that price that is what it gets sold for. If one seller has a wildly different price (for example a significantly lower price) then the financial system self corrects by other sellers starting to lower their prices to match the much lower price. The seller who had their price significantly lower will also pick up that something is amiss and adjust their price higher. Eventually the price for the given product will be consistent across the market. One of the key takeaways for me from this session was how much of the market is held in place by people's sentiment - gone are the days of currency backed by physical asests.
This is also where the concept of a market maker comes in which makes this whole process much clearer. This is a person or entity who agrees to buy something at a listed price. They do this by communicating with other market makers where they handle the other side of the transaction for example if a client is selling dollars and wants Euros the market maker agrees to buy the dollars at a given rate and then speaks to other market makers to source the Euros. They can then see if prices need to be adjusted and adjust accordingly.
This is done by collecting the prices of an instrument for a number of different time frames and plotting that onto a curve.
Trading the Instruments
There are two ways to do this:
- OTC: Over The Counter. This is when sellers and buyers interact with one another directly. For example if someone buys a fixed deposit from a bank then this is an OTC transaction as the buyer deals directly with the bank
- Exchange: this refers to something like a stock exchange where the exchange is responsible for facilitating the interaction of buyers and sellers. Buyers and sellers do not interact directly and instead go via brokers. One key thing that exchanges provide over OTC is mitigation of credit risk ie they ensure that buyers and sellers honour their commitments. This is the role of a clearing house within an exchange where they know both the buyer and seller and only allow a transaction through if both the buyer and seller portions are in place.
I learnt a tonne more during the day but in quick reflection the above points were what stood out the most. The facilitator for this training has many years of practical experience in the industry which really shows in their course material.