Supply - demand - electronic markets

supply and demand in an electronic market
Supply and demand is a difficult subject.
It can be dealt with in two ways. Theoretical or Practical.
Nearly 99% of the information available is theoretical - for very good reason.
It is safer to stay within the bounds of text-book theory.

released September 2006
The final chapter in a project commenced in 2002.
This article has been the most difficult.


can you measure Supply and Demand real-time? - does anyone know?

category

timeframe

objective

theoretical

theory of

supply and demand

what it is

how it works

dominant use

used by educators to teach concepts

text books define the principles,

laws and terminology

abstract 

can be applied to

any market involving

buyers and sellers

how it's applied

usually used in the past tense

real-estate, stocks, shares, commodities

used by governments to adjust policy settings

used by companies in production planning

historical 

the past, yesterday

last week, last year

used to explain what happened

price of shares went up yesterday

dow jones index rose on strong demand

price of oil rose on strong demand

price of oil rose on supply concerns

house prices rose last year on strong demand

immediate 

real-time, live

identify what is happening now

are they buying?

are they selling?

 

granville's engine
on-balance-volume - the unfinished manuscript
When viewed as a process, On-balance-volume is supply and demand.
Don't view at it as an indicator. Instead, examine the concepts behind it.
Introduced to Granville's "Volume Complex" many years ago. It was simple - as all good things are. It's open source. A white box. Have yet to find anything that comes close to it. It was based on end-of-day principles with one defect. Kept coming back to it. Granville is a genius, who left behind an unfinished manuscript. Given the opportunity he may well have completed it himself. Keep in mind Granville was working with data available in the 1970's. The missing link needed to complete his work would appear 20 years later. While working with real-time electronic feeds, we modified it to overcome the deficiency. It's not hard. Just need to know where to look. It measures real-time supply and demand. It's simple. It works. The Official site of Joseph Granville
 

measuring supply and demand
Price is Y axis. Time is X axis
Price opened at 5017
controlzone boundary was 5107
pre-open low was 5103
Yellow is the lunchtime session
White on left is AM session, White on right is PM session

The values in the screenshot are a progressive balance of net supply-demand.
The values at each price point are our modified implementation of granville's supply and demand.

Price changed to the second column at price row 5021
As price fell below the low of the first column and heading toward the Pre-open Low, demand is increasing, demonstrating buying is occurring. And getting stronger thereafter.



 

supply and demand in an electronic market
Quantity is the foundation of measuring supply and demand.
according to investopedia - futures volume
"There is little research into the volume of futures compared to stocks".

measuring supply and demand
a vertical market
Measuring supply and demand in a vertical market is straightforward. Manufacturers obtain raw materials from suppliers, manufacture product and distribute through retailers. Commonly known as the "supply chain". Supply of raw materials and product are controlled by demand at the end of the chain. In the long run, the supply chain is stable. Retailers, manufacturers and suppliers measure their requirements by the quantity of sales going out the door. Participants are known and co-operate with one another. A good example is "just-in-time" ordering systems. The components are identifiable. Orders, customers, deliveries, suppliers, time, seasonality, stock holdings etc. Price is usually set at the beginning of a contract period and doesn't fluctuate on a daily basis.

a horizontal market
In the short term, futures markets are horizontal or flat. The market structure, that is, not price. There is no "supply chain". Buyers (demand) and sellers (supply) do not know one-another. Participants can be buyers one minute, sellers the next. The identifiable components are price, time, and size. Suppliers and customers are anonymous. Each can participate, hit, sit, withhold, wait, suspend, exit, delay, cancel, place fictitious (dummy) orders at will.

a futures market
Measuring supply and demand in a futures market leads to identification of
    • (a) short term intra-day trading, and
    • (b) medium term arbitraging.
Appreciation of the following requires an understanding of arbitraging and the role of arbitragers. That's what its all about. Because the role of the future is to track the physical cash, then while cash is rising, the future is either,
    • (a) being bought - no arbitraging, or
    • (b) being sold, into a rising market - arbitraging.

what factual information can be established
The following example is based on a single trade of 1 lot where price has just risen 2 points.

Known facts are :-
There is one buyer and one seller
Price has risen 2 points.
Quantities are available on both the bid and the offer.
Buyers and sellers always have opposing views of the market. Which one is right.

scenario 1 - demand
If someone hits the raised offer, it can be stated :-
The buyer was more enthusiastic than the seller because the buyer met the sellers price.
The transaction was a buy. Whether it be opening long or covering short - doesn't matter.

Applying Mark Douglas's "Psychology of Price" :-
The buyer considers there is further capacity for price to rise.
The seller is relaxed, or indifferent, and considers there is limited capacity to rise.

scenario 2 - supply
If someone hits the raised bid, it can be stated :-
The seller was more enthusiastic than the bidder because the seller met the buyers price.
The transaction was a sell. Whether it be opening short or covering long - doesnt matter.

Applying Mark Douglas's "Psychology of Price" :-
The seller considers price has topped and cannot rise further.
The buyer is relaxed, but has the view there is further capacity for price to rise.
The seller is keen to lock in profits by covering long, or to open a short position.

Open Interest
Depending on whether the one transaction :- opens 2, or opens 1 closes 1, or closes 2 :-
Open interest will either, increase by 2, remain constant, or reduce by 2.
Because the conditions apply equally to both the above scenarios, open interest is meaningless.
It could rise by 2 in the supply scenario, and fall by 2 in the demand scenario.
For a full discussion see investopedia - discovering open interest

practical
Two Institutions, FundOne and FundTwo, intend to open 5000 positions FundOne long. FundTwo short.

in examples 1 through 4 there is no "head on" contention.

example 1
Both Institutions meet for breakfast and agree to take the other side of each other.
They agree on a price, and handshakes are the order of the day
Result. Two satisfied customers. No market contention. Supply/Demand equilibrium.
Net supply demand is zero

example 2
Both Institutions place their orders - on the open - simultaneously. Done
Result. Two satisfied customers. No market contention. Supply/Demand equilibrium.
Net supply demand is zero

example 3
Both Institutions place their orders - by arrangement - simultaneously. Done
Result. Two satisfied customers. No market contention. Supply/Demand equilibrium.
Net supply demand is zero

example 4
InstitutionOne executes long in the AM, and commences buying program. Done by Midday.
Result. Market rises all morning. And comes to rest on completion of the program.
InstitutionTwo executes short in the PM, and commences selling program. Done by close.
Result. Market falls all afternoon. Comes to rest on completion back where it started the day.
Net supply-demand at 12:00pm is +5000
Net supply-demand at 04:30pm is zero
Net supply demand curve is a positive parabolic curve.
Reverse the order of execution, and Net supply demand becomes a negative parabolic curve.

example 5
Both institutions place small orders, 5 lots at a time progressively during the day. All day.
Teasing one another, looking at one another, but still doing business.
Net supply-demand at 04:30pm is zero
Net supply demand curve is a flat line.

example 6
Both institutions place small orders, 5 lots at a time progressively during the day. All day.
Teasing one another, looking at one another, but still doing business.
InstitutionOne takes a break at 11:00am for an hour.
Unless InstitutionTwo takes an identical break, there will be contention in the market.
InstitutionTwo is the seller. InstitutionOne, the buyer has disappeared. Creating a vacuum.
Price must fall. Reverse the order of the time break and price will rise.
Net supply-demand at 04:30pm is zero



black box system
use the grey-box - (grey-matter) wetware - it works better - in the long run.

black box theory
Black box theory differs from a black box system.

A black box system, as applied to trading systems, is commonly described as any system where the user is presented with the results of a process and asked to accept the results without access to the formulae that give rise to the conclusions. The inner components are known, but only by the author.
Bruno Latour in his book Science in Action, described black box theory as a box containing a number of smaller boxes. The observer, not understanding the function of the outer box opens it and examines the collection of inner boxes. If there is understanding of all of the inner boxes except one, then the observer opens that one. Inside they find another collection of boxes. They examine this collection, and not understanding one of the boxes, open it and so on. This process of drilling down until understanding is finally obtained, is a way of establishing the building blocks to understanding. The process is then reversed, re-examining each box on the way out until one fails. Then the drill down process is repeated again, this time going down a different path.

Latour's work is a recognised university text. It clearly establishes that evidence of an established/accepted theory is, the absence of controversy, and the acceptance of a single, final authority. i.e. Einsteins Law of Relativity, Watson and Crick's Double Helix DNA. He argues the mere existence of controversy and competing theories is evidence the jury is still out, and yet to be accepted. Which defines the current state of Technical Analysis.

Additional information