CLASS 4 - Negotiation: Supply and Demand
The market we operate in is called a competitive market (as opposed to a protectionist, monopolistic, or concentrated market). In this kind of market, the trading of financial securities takes place when a balance price is reached, also known as the "last" price. This is the price at which the seller’s offer (ASK) equals the buyer’s demand (BID).
From a graphical point of view, the equilibrium price or "last" is the point where the supply curve and the demand curve intersect.
How the Price Is Determined
The price negotiation in the financial markets works just like in any other free market in the world. It is influenced by several key factors:
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The intrinsic value of the asset
This means the real value based on:
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Tangible goods (like properties, equipment)
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Intangible assets (like patents, brand reputation, intellectual property)
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The emotional/psychological value
The price is also affected by how buyers and sellers feel or perceive the asset—this includes expectations, trends, fear, greed, or confidence.
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Quantity (supply)
Quantity plays a major role. Remember: the rarer and more exclusive something is, the more valuable it becomes.
This also applies to financial instruments:
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A stock split increases the number of shares, which lowers the value of each share.
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A reverse split reduces the number of shares, which raises the value of each share.
The Market Is a Collective Phenomenon
Finally, it’s important to understand that the market is a mass phenomenon. This means that prices aren’t determined just by logic or formulas, but also by the actions of many traders and investors at the same time.
So another essential element to consider is:
When many people take the same action—say, everyone starts buying—a stock's price can shoot up, even if its real value hasn’t changed.
When the Price Falls: the Buyer’s Market
As we’ve seen, the price of a financial asset drops when supply exceeds demand.
In other words:
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There are many sellers but few buyers.
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Sellers, in order to get rid of the securities they purchased (sometimes referred to as “balloons” or “bags”), are forced to lower the price if they want to sell.
👉 This situation is called a "buyer’s market", because it favors those who are buying (they can purchase at lower prices).
From a graphical perspective:
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The supply curve shifts downward.
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A new, lower intersection point with the demand curve is formed.
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Result: a new, lower equilibrium price.
When the Price Rises: the Seller’s Market
On the other hand, the price rises when demand exceeds supply.
What happens:
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There are more buyers than sellers.
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Buyers create buying pressure (eagerness to purchase).
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Sellers can take advantage and raise the price up to the maximum buyers are willing to pay, known as their “reservation price.”
👉 In this case, we talk about a "seller’s market", because it benefits those who are selling.
Graphically:
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The supply curve shifts upward.
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A new, higher equilibrium point is formed, resulting in a higher price.
The price of a security is formed by the meeting of supply and demand, that is, between those who want to buy and those who want to sell. As happens in any commercial transaction, the buyer will try to purchase the desired quantity at the lowest possible price, while the seller will try to maximize their profit by selling at the highest possible price (just like at your local fruit and vegetable market).
This dynamic results in the market setting a “last price” or “equilibrium price” (last), which is the price at which the transaction actually took place. This price represents the lowest price the seller was willing to accept and the highest price the buyer was willing to pay.
Moreover, the best buy and sell offers are gathered and organized in a system called the “Book”: an electronic register that conveniently orders the bids and asks related to the financial instruments available on the market at a given moment. This Book updates constantly and very quickly during the trading day, especially when the price is particularly volatile.
As you will notice yourself when trading, the bid price (the price buyers want to pay) does not exactly match the ask price (the price sellers want), differing by one or a few cents. This difference is called the Spread, and it is the gap that must be bridged by either the seller or the buyer for the transaction to take place.
But why does the Spread exist? There is a clear reason behind it: this difference serves to constantly maintain liquidity in the market. To help you understand better, here’s a simple analogy: think of the market as a giant mechanical clock made up of many gears. These gears must always be well lubricated, otherwise the clock would stop working. Oil is used to make the gears slide smoothly against each other.
In the same way, liquidity acts like oil in the clock, allowing financial trades to flow smoothly in the market. Without liquidity, the market would seize up; it would be like trying to swim without any water around you—impossible, right?
Therefore, a mechanism is needed to ensure liquidity never runs out in the market. That mechanism is the Spread. It’s a brilliant idea because it keeps liquidity constant automatically during every trading day.
It’s important to know that the wider the Spread, the less liquid the market is, and the harder it is to trade that asset. Conversely, a narrow Spread means there is enough liquidity in the market.
Finally, as you might guess, the Spread represents a profit for banks, which allows brokers some flexibility in their operations and helps prevent trades from being blocked over just a few cents difference.
ex: Imagine you’re looking at the price of a stock XYZ.
The difference between these two prices is €0.05, or 5 cents. This difference is called the Spread.
If you want to buy the stock immediately, you have to pay the ask price of €10.05.
If you want to sell the stock immediately, you will receive the bid price of €10.00.
So, to complete an immediate transaction, either the buyer or the seller must "cover" this 5-cent spread.
This Spread exists to keep liquidity in the market because it provides a margin for those who facilitate the trades (like banks and brokers). The smaller the spread, the more liquid the market is, meaning it’s easier to buy or sell quickly without big price differences.
If the spread were wider, for example 20 cents (bid at €10.00 and ask at €10.20), it would be harder to trade quickly because the difference between supply and demand prices is bigger.
Conclusion: The Invisible Hand That Sets the Price
At its core, the financial market is a living negotiation between buyers and sellers. Price is not fixed—it is discovered. It reflects the balance of emotions, expectations, urgency, and strategy between two opposing forces. When demand overcomes supply, prices rise and sellers gain the upper hand. When supply exceeds demand, prices fall and buyers take control.
The market’s engine is constantly turning, and liquidity is its fuel. The Spread may seem like a minor detail, just a few cents—but it plays a critical role in keeping that engine running smoothly. Without it, trades would stall, confidence would drop, and the market would grind to a halt.
Understanding how price is formed, how the Spread works, and what signals a liquid or illiquid market gives you a major advantage: you stop reacting blindly and start thinking like a trader.
In the end, mastering these fundamentals is like learning to read the language of the market itself—and once you do, every price movement starts making sense.
