Price Discovery and Information in Markets
Price discovery is the process by which scattered private information becomes a single public number. Nobody knows what an asset is worth. Many people know a little, and trading is the mechanism that aggregates those fragments.
How information enters a price
Someone with an insight buys. Their buying consumes offers and pushes the price up. Market makers observe the buying, infer that their fair value was too low, and raise their quotes. Other participants see the higher price and update too.
The information never had to be announced. It arrived through the trade itself, and this is the crucial mechanism: prices move because informed traders trade, not because they publish.
For a market maker, this means every fill carries information. Being lifted repeatedly is evidence, and the skill is separating flow that carries information from flow that is merely noise.
Efficiency, in three strengths
The efficient market hypothesis comes in versions, and it is worth knowing which is being claimed.
Weak form: prices reflect all past prices. If true, technical analysis has no edge. This is close to a description of a Markov process, where the current price contains everything the history had to say.
Semi-strong: prices reflect all public information. If true, fundamental analysis of public data has no edge.
Strong: prices reflect all information, including private. Essentially nobody believes this, since insiders demonstrably profit.
The paradox worth understanding
If prices already reflected all information, nobody would be paid to gather it. But if nobody gathered information, prices could not reflect it. Perfect efficiency is therefore self-defeating.
This is the Grossman-Stiglitz paradox, and its resolution is that markets must be slightly inefficient. There has to be enough mispricing to compensate the people doing the work of finding it. That margin is the entire business model of the industry.
Markets are efficient enough that beating them is hard, and inefficient enough that it is possible. The residual inefficiency is precisely the payment for the research that removes it.
Where discovery happens
Price discovery concentrates in particular places and times, which is practically useful to know.
The most liquid instrument leads. Index futures typically discover price before the underlying stocks; the most active option strike leads the surface. Less liquid related instruments follow.
Opens and closes. Auctions concentrate accumulated overnight information into a single price, which is why they carry disproportionate volume. See auction theory.
Around news. Scheduled releases produce intense, compressed discovery in the seconds after the print.
What it means for quoting
If you make a market in an instrument that follows another, your fair value should update from the leader, not from your own book. A market maker in a single stock who waits for their own order book to move has already lost to anyone watching the futures.
This is also the honest answer to why speed matters: not to predict the future, but to incorporate information that already exists somewhere else before someone trades against your stale quote.
Ask which instrument leads yours. Pricing off the leader rather than off your own book is often a larger edge than any improvement in spread optimisation.