One general goal for investing is to own assets that will appreciate over time. As an investor, note that there are different types of markets to consider when you want to execute a trade. The auction market is primarily concerned with executing trades among buyers and sellers.
Having a lot of buyers who are interested in buying a financial instrument will make that asset more valuable. Also, when liquidating the asset to cash, the market gets to set the prices realized for the assets being sold.
In this article, you will get to know what an auction market is, how it works, and differentiate between the auction market and the dealer market.
What is an Auction Market?
An auction market is a trading market where buyers and sellers trade assets. In this market, a trade is executed when the highest price from the buyer matches with the lowest price the seller is willing to accept. It’s an environment where a bidding process facilitates competition between buyers and sellers.
How Does an Auction Market Work?
This market strategy is quite different from OTC (over-the-counter) market strategy, where trade is carried out directly between two parties without a broker. The auction market can be done physically and also via the computer. But there’s no direct negotiation between the buyers and sellers.
Here, the seller place offers in the desired financial instrument. Also, buyers place multiple bids in the desired financial instrument that is available in the market. Then the trade executes when the highest bid price is matched with the lowest ask price.
In this process, there could either be multiple buyers and multiple sellers or multiple buyers and one seller.
Examples
We’ll use the case scenario where there are multiple buyers and multiple sellers to explain further.
Three buyers are interested in buying a share of company ABC with the bid prices of $5.00, $5.03, and $ 5.5 respectively. Whereas, three sellers had offered to sell their shares of company ABC for $5.5, $5.7, and $5. 9 respectively.
In this scenario, the highest bid price of $5.5 will be matched with the lowest sell price of $5.5 and the trade will be executed. However, the rest of the orders will not be executed immediately and the current market price of company ABC will be adjusted to $5.5.
Auction Market vs Dealer Market
Going through the characteristics of the dealer market, it is quite different from the auction market in various ways.
As explained earlier, an auction market is a competitive market where trade is executed by matching the buyer’s highest bid price with that of the lowest sell price. On the other hand, a dealer market is a market where dealers post a fixed price to sell a desired financial instrument. Without involving a third party, trade is executed when an investor accepts the dealer’s fixed price.
In the auction market, there’s a single platform where buyers and sellers post the prices they want to buy and sell. However, this process ensures that the financial security is sold at a good price. In the dealer’s market, buyers and sellers get to know the bid price and offer price electronically but the trade is executed through dealers.
The auction market operates an order-driven market where buyers and sellers engage in competitive bidding. On the other hand, dealers get to fix the sell and buy prices. That is to say, the dealer market operates a quote-driven system.
Conclusion
The main focus of the auction market is to connect buyers and sellers. In doing this, brokers stand in place of the individual owners of the securities. It’s important to note that, no matter how intense trading might be, each market operates with a set of guiding rules.
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