There are many ways to price the market. One famous that accomplishes that is the CAPM method, which is analyzed in “The Capital Asset Pricing Model (CAPM) by William Sharp” article. The downside of the CAPM method is that it is more suitable for longer-term use. For a shorter, intra-day use, a more practical approach would be to price the market according to the market action theory.
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The Life of Pail Samuelson and The Market Auction Theory
Paul Samuelson (1915–2009), was born in Indiana in the US and grew up the Chicago. When in high school, Samuelson started studying the stock market, up to the point where he helped his teacher to select stocks in which he would invest. It was the booming market of the ’20s after all.
Samuelson would receive his bachelor’s and master’s degrees from the University of Chicago, and his Ph.D. degree from Harvard University in 1941.
After finishing his education, he would be employed by MIT as an assistant professor, and he would stay in that institution for the rest of his life.
He received the Nobel prize in economics in 1970, and he would be the first American to do so. His contribution to what is known as “the theory of consumer behavior”, as it has been described in his book “Foundations of Economic Analysis”, published in 1947, is the cornerstone of the field of microeconomics
Still today, his work remains among the most cited in the field of economics.
The image has been taken fromhttps://www.nydailynews.com/
Among Samuelson’s countless contributions to economics was auction market theory. He developed this idea in the ’50s and it has had a massive effect on the way financiers view prices in the financial markets up to this day.
The basic concept behind this idea is that supply and demand set an asset’s price in the market to the point of their intersection when supply meets demand. The supply curve represents the price at the y-axis and the quantity at the x-axis in which suppliers are willing to sell their assets. The demand line represents the price at the y-axis and the quantity at the x-axis in which buyers are willing to buy their assets.
If there are no sellers, the price continues to go up in the “search” for sellers, and when there are no buyers, the price of an asset follows a downward movement in the search for buyers.
The image has been taken fromhttps://www.britannica.com/
At the intersection point, supply and demand are in “balance” or have found a “fair price” at the level where buyers and sellers agree and transact with each other.
This indefinite process is known as “market auction”.
The Black Monday of 1987
On October 19, 1987, the Dow Jones Industrial Average index fell by more than 22%. This was the largest one-day percentage decline in its entire history.
This event was caused by a large increase in the supply of stocks because many people wanted to sell, and a large sudden decrease in demand, which meant that just a few people wanted to buy, which was triggered by a slowing economy, and tightening monetary policy.
The Depth of Market
In order for the market auction theory to be put into use, one would require data for the buys and sells of a particular asset or market, logged in the “order book”.
This information, which constitutes the supply and demand, also known as the bid and the ask, is usually been displayed in a vertical price scale called “depth of market”.
The image has been taken byhttps://www.financemagnates.com/
On the above screen, one could see the limit orders as set by the users, as well as the orders that already took place as colored bars indicating the number of transactions for each price level. In the above example, one could see that at the “121'169” level have taken place “2.60K” selling transactions. With this information, one can assume that sellers feel comfortable selling at this level, and their supply meets the demand of the buyers.
Market Profile
Peter Steidlmayer continued the development of the market auction theory when he was a trader at the CBOT (Chicago Board of Trade).
According to his LinkedIn profile, Steidlmayer received a degree in economics from the University of Notre Dame in 1971 and began his career as a trader at the CBOT, where he remained from 1959 to 1985. He later founded the Steidlmayer Trading Corporation, a research and consulting firm that specializes in the study of financial markets.
CBOT introduced the buyer and seller volume price data to the market through a chart called “market profile” in 1985.
The image has been taken fromhttps://www.finnotes.org/
Two years later market profile analysis was introduced as a part of an academic curriculum to the public.
In contrast to the depth of the market which displayed information in two dimensions, meaning price and volume, the market profile adds a third dimension, time.
The image has been taken fromhttps://www.trading-fuer-anfaenger.de/
In the above image, one can see the price as it moves in relation to time in the form of candlesticks, as well as, colored in blue, the volume traded according to each level.
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