Let’s break down the components of price change mechanics to observe why prices fluctuate. The first question we need to ask is how do prices change?
HOW DOES A PRICE CHANGE?
Most markets in finance are dual-auction. This is both buyers and sellers coming together, offering to sell, and bidding to buy, in an attempt to come to an agreement to trade.
Interestingly, if an instrument is for instance rising, this does not mean there are more buyers than sellers. There are always an equal number of buyers and sellers at each price. After all, a purchase cannot be made without a buyer and seller, and vice versa for a sale. The impact on price changes from the urgency to trade (order types) and the liquidity available.
If you take a look at a market you will see two prices, the bids, and the offers. If you want to buy immediately, you must lift the offer, paying the lowest sale price available at that moment. If you want to sell immediately, you must hit the bid, paying the highest purchase price. The difference between these two prices is called the spread. Your order to trade is called a market order. The transactions taking the other side of your trade are limits. There are many different order types in the markets, but they are all based on these two fundamental orders.
A market order is an order to trade at the current best available price. Market orders remove liquidity, and are not guaranteed. For instance, if there are not enough available offers at the price you want to buy, your trade will be transacted at higher prices. This is slippage.
A limit order is an order to trade at a specific price, or better. Offers to sell can only be at the current offer price or higher, and bids to buy can only be at the current bid or lower. Limit orders provide liquidity, and they are therefore subject to inverse slippage. This means that if there are no sellers at your bid price, your trade will be transacted at lower (and therefore better) prices.
To summarise, price rises when all the available offers are lifted.
Price falls when all the available bids are hit.
The point to note: prices change when liquidity is removed.
So, why does a price change?
It’s a good question, and a very deep one. There are countless reasons for individual transactions. They can be explained by a magnitude of reasons, individuals and groups interacting within a complex system, for economical reasons, further explained by human phycology. Human biases and economical inefficiencies exist, and all have an impact on price changes. As with the popular saying that there are more combinations of a game of chess than there are atoms in the observable universe, one can get bogged down in trying to dissect the reasons of trillions of individual transactions, especially when often they are unexplainable, even by those making the transactions.
The best option is to observe the conduct, research, and create basic models. This is what we will be continuing to do on this website.