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A little story about price discovery
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A little story about price discovery


By Paul Orford October 2, 2019
A little story about price discovery

Sometimes a simple story can teach you way more about a subject than anything else. So, for this entry, we’re going to take a break from the charts and the stats and share the following little anecdote with you.

Former Federal Reserve insider Danielle DiMartino Booth often tells the following highly quotable story to her audiences. The original version is said to have been shared with her by UBS’s legendary Wall Street trader, Art Cashin, who’s been on the trading floor of the New York Stock Exchange for more than 50 years.

The story is about the process of determining the market price and how this works in practice. We share it with you here as an important lesson regarding what’s goes on, psychologically speaking, behind the figures that you see on the chart or the ticker. Both Booth and Cashin credit the story as having taught them a great deal more about price discovery than any textbook.

Buyers and Sellers

The two protagonists of this story are Charles Lewis Tiffany (of the jewellery empire) and John Pierpont Morgan (of the banking empire). The story goes that Tiffany made it his business to be aware of the tastes of the most prominent and wealthy figures of New York high society. To this end, he was aware that Morgan had a penchant for rare diamond stickpins.

When, on one fine day, Tiffany happened to come across a rather rare and particularly exquisite diamond-studded stickpin, he immediately knew who of all his customers was most likely to be in the market for it. Tiffany placed the pin in an elegant gift box, had it wrapped in expensive paper and then sent a messenger to deliver the item to Morgan’s office.

Morgan receives Tiffany’s offer

The package was accompanied with a note praising Morgan’s impeccable tastes and assuring him that contained therein was a quite stunning example of the kind of luxury and fine craftsmanship that Morgan sought, saying that the stickpin would make a fine addition to his already impressive collection.

The note was signed off by Tiffany informing Morgan that the price for the pin was $5000 and that if this sum was acceptable to him he could send a man to his office the following day with a check. If not, he could send back the pin.

Tiffany receives Morgan’s bid

On the following day, Tiffany received Morgan’s messenger in his office. He was carrying the same gift box with a different kind of wrapping paper and an envelope containing a check and note addressed to Tiffany. The note read that Morgan was highly impressed with the magnificent piece and thanked Tiffany profusely for considering him as a buyer.

However, it continued, he believed that $5000 was slightly on the pricey side for the item in question. The note concluded by saying that Morgan had included a check for $4000 and that if Tiffany chose to accept the sum he could feel free to keep the check and send the box containing the stickpin back to him.

Tiffany’s dilemma

Tiffany found himself in something of a dilemma. He sat at his desk for a while, He stared at the check. $4000 was a handsome sum of money and he was very tempted to accept it, particularly with Morgan’s man waiting in his office for a response.

He took a few moments more, then made up his mind. He looked up at the man and informed him that he may return the check to Mr. Morgan, that the price of $5000 was final for that particular item. The man nodded and bid him farewell.

The punchline?

Tiffany sat in silence for a while, mulling over what had just taken place. He considered and reconsidered the choice he had just made. He had opted to refuse the certainty of $4000 in the uncertain hope of finding a buyer who would give him what he believed was the true value of the stickpin.

Eventually, when he had satisfied himself that he’d made the right choice, he unwrapped the gift box and opened it up. As he did so he saw to his alarm that it didn’t contain the stickpin but only another envelope. He hastily tore it open and removed the contents. There was another check from Morgan, this one for $5000, and another note with four words scrawled on it. The note read: “Just checking the price.”

 

Disclaimer: This article is not investment advice or an investment recommendation and should not be considered as such. The information above is not an invitation to trade and it does not guarantee or predict future performance. The investor is solely responsible for the risk of their decisions. The analysis and commentary presented do not include any consideration of your personal investment objectives, financial circumstances or needs.

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October 2, 2019