What is an Auction Market?
An auction market is a stage for buyers and sellers to trade stocks by making competing bids and offers. It executes at a matching price where the buyer’s highest bid matches the seller’s lowest offer price.
Table of contents
Key Takeaways
- In an auction market, buyers and sellers trade stocks by putting up competing offers and bids. The lowest offer price made by the seller and the highest bid made by the buyer is matched in this transaction.
- Auction markets also have a double auction market that allows buyers and sellers to give a price acceptable from bids, and offers are given a list.
- Chicago Mercantile Exchange (CME) and the New York Stock Exchange still operate in the auction market open outcry system.
- NYSE converted from strictly operating on the auction market to a hybrid market in 2007 that works on both the electronic trading system and the auction market.
Example
Suppose a buyer is interested in buying a share of ABC Ltd. In the market, it trades at $101 per share. He puts bids as follows: $101.05, $101.10, $101.15, $101.20, $101.25, $101.30. Similarly, sellers willing to sell the same company share in the marketplace offer $101.30, $101.35, $101.40, $101.45, $101.5, and $101.55. In this scenario, the buyer’s highest price is ready to pay, and the lowest price the seller is ready to accept is $101.30. Therefore, the trade gets executed at $101.30, and the current share price of ABC Ltd. will be $101.30. While all other bids of the buyer and ask if the seller remains pending until bids and ask matches and next trades executed in the market.
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How does the Auction Market Process Work?
The process differs from the OTC market since no direct negotiations occur between buyer and seller.
- The buyer places multiple bids on the desired financial instrumentFinancial InstrumentFinancial instruments are certain contracts or documents that act as financial assets such as debentures and bonds, receivables, cash deposits, bank balances, swaps, cap, futures, shares, bills of exchange, forwards, FRA or forward rate agreement, etc. to one organization and as a liability to another organization and are solely taken into use for trading purposes.read more available in a market.
- The seller places multiple offers in the desired financial instrument market.
- The order matching mechanism focuses on putting up the highest bid price Bid PriceBid Price is the highest amount that a buyer quotes against the “ask price” (quoted by a seller) to buy particular security, stock, or any financial instrument. read more from the buyer and the lowest offer price from the seller.
- If the highest bid price and lowest ask priceAsk PriceThe ask price is the lowest price of the stock at which the prospective seller of the stock is willing to sell the security he holds. In most of the exchanges, the lowest selling prices are quoted for the purpose of the trading. Along with the price, ask quote might stipulate the amount of security which is available for selling at the given stated price.read more match. The trade is executed on those securities and decides the current market price on this mechanism.
- The order status remains pending if the bid price and offer do not match.
- An order executed will be processed for settlement as per exchange rules.
- In general, the auction has one seller and multiple buyers. However, in this, there are numerous buyers and sellers.
- Continuous process deciding the current market price Market PriceMarket price refers to the current price prevailing in the market at which goods, services, or assets are purchased or sold. The price point at which the supply of a commodity matches its demand in the market becomes its market price.read more through this order matching mechanism.
- Auction markets also have the term known as a double auction market, allowing buyers and sellers to submit a price they feel acceptable from a given list of bids and offers. The trade will proceed to execution when bid and ask prices match.
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Video Explanation of Auction Market
Example
Chicago Mercantile Exchange (CME) and the New York Stock Exchange are still operating in the auction market open outcry system. An electronic trading method that more or less still operates on the principle of an auction market system but electronically, and every buyer and seller gets access to bid and offer prices in the market on display and make their own decisions. Similarly, reduced cost and improved trade execution speed compared to open human outcry speed, an environment that is now less vulnerable to manipulation. In addition, the availability of the electronic system to any home computer and smartphone free of the cost compared to the open outcry auction market created a popularity for adaptation to electronic trading method.
As time passed with the invention of new technology, all exchanges adapted the method of an electronic trading system. In 2007, even NYSE converted from strictly operating on the auction market to a hybrid market, which operates on both the electronic trading system and the auction market. Some stocks are still traded on the trading floor Trading FloorTrading Floor is a place where traders buy and sell shares, fixed income securities, commodities, foreign exchange, bonds, options, etc. It is the market segment in which dealers trade financial instruments in various exchanges, for example, Bombay Stock Exchange (BSE) and the New York Stock Exchange (NYSE).read more, which has an extremely high price.
In the auction market, they bound brokers by exchange rules, which act as buyers and sellers representing their clients to make competitive bids and offers to make a trade. Therefore, many investors trading in these markets keeps a continuous eye on the news and moods of the trading pit.
Government Securities Auction
Many governments of various countries hold the auction for their securities in the market, which is open to the public and large financial institutions. Bids are mostly accepted electronically and divided into two groups: competing for bids and non-competing bids. The non-competing buyers are given preference and are guaranteed to receive several securities after the amount as per the minimum and maximum limit of the bid amount. In the case of competitive bids, once the auction is closed, bids are reviewed, and they list competing bids as per bid price. Then, the remaining securities they sell to higher or lower bids.
E.g., The US Treasury holds auctions to finance certain government activities.
Auction Market vs. Dealer Market
The following are the differences:
| Differences | Auction Market | Dealers Market |
|---|---|---|
| Definition | A market where buyers enter competitive bids and sellers enters competitive offers. They match the highest buyer’s bid and the lowest seller’s offer and execute a trade in that financial instrument. | A financial market system in which numerous dealers post prices at which particular instrument security will be bought or sold. |
| Current Price matching | The highest bid price from the buyer and the lowest price offered by the seller when they execute the matched order. | “Dealer”- designated as “market maker” creates liquidity and transparency, showing an electronic display of prices where buyers’ bids and sellers’ offer’ prices are on display. |
| Market Contents | Futures and options markets are auction markets. | OTC securities market and Govt. securities market are the dealers market. |
| Focus on | Order driven markets | Quote-driven markets |
| Example | The buyer of security put bids on the share of the company of ABC ltd. Priced around $250 as $249.2, $249.3, $249.4, $249.5 while seller put offers price on same company share as $249.5, $249.6, $249.7, $249.8. Therefore the highest bid from the buyer and the lowest price offered from the seller, $249.5, is matched, and the order gets executed, and the market’s current price comes to $249.5. | The dealer has enough XYZ company available with other market makers at $350/$360 and is willing to sell some quantity into the market. So the dealer can post a quote with a bid-ask of $345/$355, so investors looking to buy this security get a $5 discount from the dealer to compare to other market makers. Like that, a seller will prefer to sell to other market makers since the dealer is bidding $5 less than other market makers. |
Conclusion
Although technologies and surveillance policies of various exchanges are innovative worldwide, the auction market also changed from an open outcryOpen OutcryAn open outcry is a trading approach generally employed on a pit for stock, option, & futures exchanges. It entails the usage of oral & gestural signs by traders to convey trading details, intentions, & acceptance.read more to an electronic trading system. The focus of this market is to connect buyers and sellers most efficiently. However, the working method has changed with time. Nevertheless, the principle remains the same per the auction market for all market operations.
Frequently Asked Questions (FAQs)
The auction process is held between 2-2:45 pm daily. It can be experienced only by the exchange member broker and selling short-delivered shares.
A double auction market is where a buyer’s price and a seller’s asking price match. Then, the trade proceeds at that price. Moreover, It does not involve direct negotiations between individual buyers and sellers during negotiations for OTC trades.
The main goal of the auction market is to bring buyers and sellers together; in the United States, most sizeable firm equity shares are traded in regulated auction markets. The biggest auction market is the New York Stock Exchange (NYSE).
The highest bidder receives the auction-marketed slaughter hogs. In the agents’ opinion, the strongest bidders purchase it from terminal commission agents. The producer pays the auctioneer a commission when hogs are sold through an auction market.
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