What is Auction Market?
Auction Market is a stage for buyers and sellers where they can trade stocks by making competing bids and offers and it is executed at a matching price where the highest bid from the buyer is matched with the lowest offer price from the seller.
Example
If a buyer is interested in buying a share of company ABC ltd. In the market, which is trades at $101 per share. He, puts bids as following $101.05, $101.10, $101.15, $101.20, $101.25, $101.30 similarly seller of who is willing to sell same company share in market place offer price as $101.30, $101.35, $101.40, $101.45, $101.5, $101.55. In this scenario, the highest price that the buyer ready to pay and lowest price which seller ready to accept is $101.30 therefore, the trade gets executed on $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.
How does the Auction Market Process Work?
The process is different from one in the OTC market since there is no direct negotiations occur between buyer and seller.
- The buyer places multiple bids in a market in the desired financial instrument available in the market.
- The seller places multiple offers in a market in the desired financial instrument in the market.
- The order matching mechanism focuses on putting up the highest bid price from the buyer and lowest offer price from the seller.
- If the highest bid price and lowest ask price is matched then the trade is executed on that securities and on this mechanism current market price is decided.
- If the price of bid and offer is not matched then order status remains as pending.
- 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 multiple buyers and sellers.
- Continuous process deciding the current market price through this order marching mechanism.
- Auction markets also have the term known as a double auction market as it allows buyers and sellers to submit a price they feel acceptable from a given list of bids and offers. When bid and ask price matched trade will proceed to execution.
Example
Chicago Mercantile Exchange (CME) and the New York Stock Exchange are examples, which are still operating in the auction market open outcry system. An electronic trading method that, more or less still operates on the principle of auction market system but electronically and every buyer and seller gets access to bid and offer price in the market on display and make his or her own decisions. In the same way reduced cost, improvement in trade execution speed compare to open outcry human speed, an environment which is now less vulnerable to manipulation, and availability of the electronic system to any home computer and smartphones at free of cost compare to open outcry auction market, created 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. From 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 still traded on the trading floor, which has an extremely high price.
In auction market brokers, which act as buyers and sellers, representing their clients makes competitive bids and offers to make a trade are bound by exchange rules. Many Investors trading in these markets keeps a continuous eye on news and moods of trading pit.
Government Securities Auction
Many governments of various countries hold the auction for their securities in the market, which is open for all public as well as large financial institutions. Bids are mostly accepted electronically and divided into two groups competing for bids and non-competing bids. Where non-competing buyers are given preference and are guaranteed to receive a number of securities subsequent to amount as per minimum and maximum limit of the bid amount. In case of competitive bids, once the auction is closed, bids are reviewed and competing bids that are listed as per bid price and the remaining number of securities are sold to bids from higher to lower.
For e.g. US Treasury holds auctions to finance certain government activities
Auction Market vs Dealer Market
The following are the differences between:
| Auction Market | Dealers Market | |||
| Definition | A market where buyers enter competitive bids and sellers enters competitive offers, highest buyer bid and lowest seller offer is match and trade in that financial instrument is executed. | 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 price of a bid from the buyer and the lowest price offered by the seller when matched order is executed. | “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 option market are auction market. | OTC securities market and Govt. securities market are the Dealers market. | ||
| Focus on | Order driven markets | Quote driven markets | ||
| Example | 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 price bid from buyer and lowest price offered from seller $249.5 is matched and the order gets executed and the current price of the market comes to $249.5. | The dealer has enough number of XYZ company available with other market makers at $350/$360 and willing to sell some quantity into the market. So the dealer can post a quote with a bid-ask as $345/$355, so investors looking to buy this security get a $5 discount from the dealer to compare to other market makers. Just like that, a seller will prefer to sell to other market makers since the dealer is bidding $5 less price than other market makers offering. |
Conclusion
Although innovation in technologies and surveillance policies of various exchanges around the world process of auction market also changed from open outcry to electronic trading system. The focus of this market is to connect buyers and sellers in the most efficient manner. Although the working method has been changed with time the principle remains the same for all market operations as per the auction market.
Recommended Articles
This has been a guide to what is an auction market and its definition. Here we discuss the example and how does the auction market work. You can learn more about accounting from the following articles –
