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Futures Trading Strategies: Price Discovery

January 15, 2019 by Daniels Trading| Tips & Strategies

If you have ever bought a house or bartered for a loaf of bread at a farmer’s market, then you have participated in the process of price discovery. Essentially, anything with palpable value has a point at which it is readily exchanged for a premium. Price discovery is the mechanism by which this premium, fee, or cost is determined.

Price Discovery in the Digital Age

From the first futures markets at the Dojima Rice Exchange to the American commodities pits of the 1990s, price discovery has had a long and storied history. Currently, it’s conducted in the digital marketplace, where participants execute futures trading strategies of all shapes and sizes in an attempt to secure market share. While the technology and means of asset pricing has changed dramatically over the years, one thing hasn’t ― business transpires at a point where buyers and sellers agree it should.

The late 20th century marked the heyday of the open-outcry auction system of trade. Participants conducted business in a variety of locales, with venues in New York and Chicago being the most prominent. It was on these markets where the pricing of almost everything under the sun was derived, including commodities, stocks, bonds, and currencies.

Under open outcry, the process of price discovery was conducted by exchanging hand signals, yelling quotes, and writing fill tickets. The success of your futures trading strategies depended upon your acumen as a trader, how loud you could yell, and who you knew in the pit. Now, trade takes place at near light speeds between participants around the globe. The digital marketplace has changed the game in two key ways, each altering price discovery:

  • Size: Since the dawn of electronic trade (mid 1980s), the markets have grown exponentially in terms of dollar value and traded volumes. For futures and options alone, more than 25 billion contracts changed hands for the year 2017.
  • Liquidity: The enormous traded volumes ensure consistent depth-of-market and liquidity throughout a variety of exchange-based offerings. This provides traders with a diverse array of viable products featuring an adequate degree of asset pricing efficiency.

These attributes of modern trade are viewed by many to boost the efficiency of price discovery and, thus, the opportunities available in the financial markets. However, some market observers believe that the integrity of price discovery has been undermined by the digital marketplace. Citing unethical futures trading strategies such as quote stuffing or spoofing as being prima facie evidence, detractors view security pricing as being routinely manipulated.

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In practice, a trader can take either viewpoint. But, given the size and interest in the modern marketplace, it’s hard to argue that trade is headed back to the open outcry pits anytime soon.

It’s All about Order Flow

Order flow is a term used to describe the placing of buy and sell orders upon a market by active participants. It’s the driving force behind price discovery — an intense real-time negotiation.

In the contemporary digital markets, traders can send and cancel large quantities of orders instantly, via the click of a mouse. Subsequently, order flow is enhanced and impacts price discovery in a collection of unique ways:

  • Tighter bid/ask spreads: Consistent order flow tightens bid/ask spreads by matching an
    abundance of buyers and sellers seamlessly.
  • Volatility: A sudden spike in order flow is capable of driving price directionally, creating volatility and wide trading ranges. This can bring strong opportunities to trend and range traders alike.
  • Slippage: Liquid markets typically feature consistently strong order flow and, in turn, depth. With no shortage of buyers and sellers eager to conduct business at each price point, the probability of receiving desirable fills is augmented substantially.

The ultimate impact of order flow on price discovery is increased and consistent liquidity. If there are an abundance of active buyers and sellers, then tight spreads, reduced slippage, and pricing volatility set the table for any number of futures trading strategies to be executed successfully.

Putting Your Futures Trading Strategies to the Test

Price discovery and order-flow are complex, nuanced subjects. For more information on these concepts and how to become a futures market participant, schedule a free, one-on-one consultation with a market pro at Daniels Trading today.

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Filed Under: Tips & Strategies

About Daniels Trading

Daniels Trading is an independent futures brokerage firm located in the heart of Chicago’s financial district. Established by renowned commodity trader Andy Daniels in 1995, Daniels Trading is built on a culture of trust committed to the firm’s mission of Independence, Objectivity and Reliability.

Risk Disclosure

THIS MATERIAL IS CONVEYED AS A SOLICITATION FOR ENTERING INTO A DERIVATIVES TRANSACTION.

THIS MATERIAL HAS BEEN PREPARED BY A DANIELS TRADING BROKER WHO PROVIDES RESEARCH MARKET COMMENTARY AND TRADE RECOMMENDATIONS AS PART OF HIS OR HER SOLICITATION FOR ACCOUNTS AND SOLICITATION FOR TRADES; HOWEVER, DANIELS TRADING DOES NOT MAINTAIN A RESEARCH DEPARTMENT AS DEFINED IN CFTC RULE 1.71. DANIELS TRADING, ITS PRINCIPALS, BROKERS AND EMPLOYEES MAY TRADE IN DERIVATIVES FOR THEIR OWN ACCOUNTS OR FOR THE ACCOUNTS OF OTHERS. DUE TO VARIOUS FACTORS (SUCH AS RISK TOLERANCE, MARGIN REQUIREMENTS, TRADING OBJECTIVES, SHORT TERM VS. LONG TERM STRATEGIES, TECHNICAL VS. FUNDAMENTAL MARKET ANALYSIS, AND OTHER FACTORS) SUCH TRADING MAY RESULT IN THE INITIATION OR LIQUIDATION OF POSITIONS THAT ARE DIFFERENT FROM OR CONTRARY TO THE OPINIONS AND RECOMMENDATIONS CONTAINED THEREIN.

PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE. THE RISK OF LOSS IN TRADING FUTURES CONTRACTS OR COMMODITY OPTIONS CAN BE SUBSTANTIAL, AND THEREFORE INVESTORS SHOULD UNDERSTAND THE RISKS INVOLVED IN TAKING LEVERAGED POSITIONS AND MUST ASSUME RESPONSIBILITY FOR THE RISKS ASSOCIATED WITH SUCH INVESTMENTS AND FOR THEIR RESULTS.

TRADE RECOMMENDATIONS AND PROFIT/LOSS CALCULATIONS MAY NOT INCLUDE COMMISSIONS AND FEES. PLEASE CONSULT YOUR BROKER FOR DETAILS BASED ON YOUR TRADING ARRANGEMENT AND COMMISSION SETUP.

YOU SHOULD CAREFULLY CONSIDER WHETHER SUCH TRADING IS SUITABLE FOR YOU IN LIGHT OF YOUR CIRCUMSTANCES AND FINANCIAL RESOURCES. YOU SHOULD READ THE "RISK DISCLOSURE" WEBPAGE ACCESSED AT WWW.DANIELSTRADING.COM AT THE BOTTOM OF THE HOMEPAGE. DANIELS TRADING IS NOT AFFILIATED WITH NOR DOES IT ENDORSE ANY TRADING SYSTEM, NEWSLETTER OR OTHER SIMILAR SERVICE. DANIELS TRADING DOES NOT GUARANTEE OR VERIFY ANY PERFORMANCE CLAIMS MADE BY SUCH SYSTEMS OR SERVICE.

GLOBAL ASSET ADVISORS, LLC (“GAA”) (DBA: DANIELS TRADING, TOP THIRD AG MARKETING AND FUTURES ONLINE) IS AN INTRODUCING BROKER TO GAIN CAPITAL GROUP, LLC (GCG) A FUTURES COMMISSION MERCHANT AND RETAIL FOREIGN EXCHANGE DEALER. GAA AND GCG ARE WHOLLY OWNED SUBSIDIARIES OF STONEX GROUP INC. (NASDAQ:SNEX) THE ULTIMATE PARENT COMPANY.

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Risk Disclosure

THIS MATERIAL IS CONVEYED AS A SOLICITATION FOR ENTERING INTO A DERIVATIVES TRANSACTION.

THIS MATERIAL HAS BEEN PREPARED BY A DANIELS TRADING BROKER WHO PROVIDES RESEARCH MARKET COMMENTARY AND TRADE RECOMMENDATIONS AS PART OF HIS OR HER SOLICITATION FOR ACCOUNTS AND SOLICITATION FOR TRADES; HOWEVER, DANIELS TRADING DOES NOT MAINTAIN A RESEARCH DEPARTMENT AS DEFINED IN CFTC RULE 1.71. DANIELS TRADING, ITS PRINCIPALS, BROKERS AND EMPLOYEES MAY TRADE IN DERIVATIVES FOR THEIR OWN ACCOUNTS OR FOR THE ACCOUNTS OF OTHERS. DUE TO VARIOUS FACTORS (SUCH AS RISK TOLERANCE, MARGIN REQUIREMENTS, TRADING OBJECTIVES, SHORT TERM VS. LONG TERM STRATEGIES, TECHNICAL VS. FUNDAMENTAL MARKET ANALYSIS, AND OTHER FACTORS) SUCH TRADING MAY RESULT IN THE INITIATION OR LIQUIDATION OF POSITIONS THAT ARE DIFFERENT FROM OR CONTRARY TO THE OPINIONS AND RECOMMENDATIONS CONTAINED THEREIN.

PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE. THE RISK OF LOSS IN TRADING FUTURES CONTRACTS OR COMMODITY OPTIONS CAN BE SUBSTANTIAL, AND THEREFORE INVESTORS SHOULD UNDERSTAND THE RISKS INVOLVED IN TAKING LEVERAGED POSITIONS AND MUST ASSUME RESPONSIBILITY FOR THE RISKS ASSOCIATED WITH SUCH INVESTMENTS AND FOR THEIR RESULTS.

TRADE RECOMMENDATIONS AND PROFIT/LOSS CALCULATIONS MAY NOT INCLUDE COMMISSIONS AND FEES. PLEASE CONSULT YOUR BROKER FOR DETAILS BASED ON YOUR TRADING ARRANGEMENT AND COMMISSION SETUP.

YOU SHOULD CAREFULLY CONSIDER WHETHER SUCH TRADING IS SUITABLE FOR YOU IN LIGHT OF YOUR CIRCUMSTANCES AND FINANCIAL RESOURCES. YOU SHOULD READ THE "RISK DISCLOSURE" WEBPAGE ACCESSED AT WWW.DANIELSTRADING.COM AT THE BOTTOM OF THE HOMEPAGE. DANIELS TRADING IS NOT AFFILIATED WITH NOR DOES IT ENDORSE ANY TRADING SYSTEM, NEWSLETTER OR OTHER SIMILAR SERVICE. DANIELS TRADING DOES NOT GUARANTEE OR VERIFY ANY PERFORMANCE CLAIMS MADE BY SUCH SYSTEMS OR SERVICE.

GLOBAL ASSET ADVISORS, LLC (“GAA”) (DBA: DANIELS TRADING, TOP THIRD AG MARKETING AND FUTURES ONLINE) IS AN INTRODUCING BROKER TO GAIN CAPITAL GROUP, LLC (GCG) A FUTURES COMMISSION MERCHANT AND RETAIL FOREIGN EXCHANGE DEALER. GAA AND GCG ARE WHOLLY OWNED SUBSIDIARIES OF STONEX GROUP INC. (NASDAQ:SNEX) THE ULTIMATE PARENT COMPANY.

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