Excellent Trading School- 1 - What is Market

WHAT IS A MARKET?

A market is the means/place/medium through which buyers and sellers are brought together to aid in the transfer of goods and/or services.

First, a market need not have a physical location. It is only necessary that the buyers and sellers can communicate regarding the relevant aspects of the transaction.

Second, the market does not necessarily own the goods or services involved. For a good market, ownership is not involved; the important criterion is the smooth, cheap transfer of goods and services. In most financial markets, those who establish and administer the market do not own the assets but simply provide a physical location or an electronic system that allows potential buyers and sellers to interact. They help the market function by providing information and facilities to aid in the transfer of ownership.

Finally, a market can deal in any variety of goods and services. For any commodity or service with a diverse clientele, a market should evolve to aid in the transfer of that commodity or service. Both buyers and sellers will benefit from the existence of a smooth functioning market.

Black Market

A black market is a forum whereby goods or services are exchanged illegally. What makes the market "black" can either be the illegal nature of the goods and services themselves, the illegal nature of the transaction or both. For example, while the buying and selling of food is not illegal, the transaction enters the black market when the good sold is illegal. And while it's perfectly legal to sell pizza and cakes, but when an all-cash restaurant does not remit to the state government the mandatory sales taxes on its transactions, it too has entered the black market.

Why Black Markets Exist?

Black markets, also called shadow markets, when people want to exchange goods or services that are prohibited by governments. Black markets also arise when people don't want to pay taxes on the transaction for legal or illegal goods or services. Some black markets exist simply because people don't realize there are laws they aren't following, such as bartering and not reporting the taxable value of the transaction but failing to pay taxes.

The licensing restrictions that governments impose on numerous services or occupations cause some services/workers to enter the black market because they don't want or can't afford to invest the time and money to obtain required licenses.

Sometimes participants in black markets don't want to act illegally, but because they lack the ability to work legally and need to make money, they don't report their jobs or income to the government. Such situations arise when illegal immigrants obtain jobs, when students traveling abroad obtain employment without acquiring a work visa or when children work in violation of minimum age requirements.

Black markets can also appear when government-imposed price ceilings create shortages. For example, if the government caps the price at which a grocery store may sell bottled water after a natural disaster, the store will quickly run out of water. 

Vendors will then appear selling that water at the higher prices people are actually willing to pay. This secondary market is a black market.

Governments can also cause black markets through overregulation. An extreme example can be found in Domestic Cooking gas LPG cylinders, where the rationing and ineffective central planning make it difficult to purchase desired quantities it. Black markets are rampant because citizens want to buy things that are difficult to come by through legal channels.

High unemployment can also give rise to black markets.

Characteristics of a Good Market

There are many markets with various terms of quality, but they are not equal, some are active and liquid; others are relatively illiquid and inefficient in their operations.

One enters a market to buy or sell a good or service quickly at a price justified by the prevailing supply and demand. To determine the appropriate price, participants must have timely and accurate information on the volume and prices of past transactions and on all currently outstanding bids and offers. Therefore, one attribute of a good market is timely and accurate information.

Another prime requirement is liquidity, the ability to buy or sell an asset quickly and at a known price that is, a price not substantially different from the prices for prior transactions, assuming no new information is available. An asset’s likelihood of being sold quickly, sometimes referred to as its marketability, is a necessary, but not a sufficient, condition for liquidity. The expected price should also be fairly certain, based on the recent history of transaction prices and current bid-ask quotes.

A component of liquidity is price continuity, which means that prices do not change much from one transaction to the next unless substantial new information becomes available. Suppose no new information is forthcoming and the last transaction was at a price of Rs.20; if the next trade were at Rs.20.05, the market would be considered reasonably continuous. A continuous market without large price changes between trades is a characteristic of a liquid market.

A market with price continuity requires depth, which means that numerous potential buyers and sellers must be willing to trade at prices above and below the current market price. These buyers and sellers enter the market in response to changes in supply and demand or both and thereby prevent drastic price changes. In summary, liquidity requires marketability and price continuity, which, in turn, requires depth.

Another factor contributing to a good market is the transaction cost. Lower costs (as a percent of the value of the trade) make for a more efficient market. An individual comparing the cost of a transaction between markets would choose a market that charges 2 percent of the value of the trade compared with one that charges 5 percent. An efficient market as one in which the cost of the transaction is minimal.

Finally, a buyer or seller wants the prevailing market price to adequately reflect all the information available regarding supply and demand factors in the market. If such conditions change as a result of new information, the price should change accordingly. Therefore, participants want prices to adjust quickly to new information regarding supply or demand, which means that prices reflect all available information about the asset. This attribute is referred to as external efficiency or informational efficiency.

In summary, a good market for goods and services has the following characteristics:

1. Timely and accurate information is available on the price and volume of past transactions and the prevailing bid and ask prices.

2. It is liquid, meaning an asset can be bought or sold quickly at a price close to the prices

for previous transactions (has price continuity), assuming no new information has been

received. In turn, price continuity requires depth.

3. Low transactions cost, including the cost of reaching the market, the actual brokerage costs, and the cost of transferring the asset.

4. Prices rapidly adjust to new information; thus, the prevailing price is fair because it

reflects all available information regarding the asset.

The reasons for the decimal pricing were threefold.

The first reason was the ease with which investors could understand the prices and compare them.

Second, decimal pricing was expected to save investors money since it would almost certainly reduce the size of the bid-ask spread

Third, this change is also expected to make the markets more competitive on a global basis since other countries already price on a comparable basis and, as noted, this would cause transaction costs to be lower.