Most of us have heard about or seen auctions, but few of us are aware of their mechanics. More importantly, auctions are also a key event in forex markets. Today, we will look at what an auction is, how it is conducted in live and online events, and other important things everyone must know about auctions. Let us find out more.
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What is an auction - the fundamentals
We can boil down the essence of all auctions into a few core properties:
- It is a competitive bidding process
- The highest bidder wins the asset
- Bidders may or may not know about the other bids, that is, they can be both open and closed
- The asset at stake has some value, at least to very select groups of people
There are several variations, nuances, and questions about auctions that we will explore now.
What is an auction?
Auctions are sales events where bidders compete against each other for a given asset or assets. The process ends when there is no one to bid higher than the last bid. The highest bidder is the winner of the auction. Many people favor auctions because they are a transparent mode of buying assets and auctioneers often get good deals out of them. Auctions are both open and close. In closed auctions, bidders do not know what the other participants are bidding. In open auctions, bidders try to outbid each other to own the auctioned asset.
Auctions are relevant in more than one sector. It is a common tool to buy and sell properties like houses and factories. In most cases, real estate goes into an auction when its owner fails to pay the mortgage. Apart from that, rare artworks are auctioned. Not just artworks, any rare collectible could be auctioned, like war memorials and historical objects. Beyond that, auctions are also an important tool in forex markets to buy and sell assets. Given its multi-sector utility, there are variations to auctions as well. There are many types of auctions to suit the needs of different situations.
What Are Pros and Cons of An Auction?
Like every other process that involves buying and selling an asset, there are both advantages and disadvantages to auctions.
The first disadvantage of auctions is the fact that entry to them might be restricted. In some cases, only members of a given exchange or organization can participate in an auction. The very structure of auctions makes it difficult to accommodate many people, as it would be in a marketplace. However, when you auction on websites like eBay, entry is usually a lot more open.
While accessibility is a disadvantage of auctions, getting competitive prices is an advantage. It is also tied to the low number of bidders. Auctions are great for getting good deals on rare items. Since the bidders are bidding against each other, they can often get an asset at much below the market price. However, the opposite also exists. Competitive bidding can take prices to an unrealistic stage, but the highest bidder has no option but to pay it.
Speaking of rare items, their very availability is an advantage of auctions. Rare item collectors would not find similar items in open markets or even black markets. Auctions bring together buyers who share enthusiasm for the same or similar item.
Limited accessibility in auctions is a direct result of another disadvantage of it - the high cost of running. Running an auction requires not just money, but also managerial skills. With so many things to look after, running an auction can get very expensive.
While the competitive process of auctions is advantageous to the sellers, it can be a deterrent for some buyers. Not everyone is equally comfortable with a high-tension bidding process. As such, many capable and willing buyers might choose to not take part in an auction.
As you can see, there are several pros and cons to auctions. Whether auctions are suitable for a particular case depends on its requirements. While auctions are not suitable for every trading situation, in some cases they are the best choice.
Now that we have had a brief understanding of what auctions are and how the process works, let us get into the finer details. We will begin by understanding the auction market, and then go on to talk about different types of auctions including forex auctions.
What is an auction market?
An auction market is a place where buyers put forward their most aggressive bids and sellers give their most competitive prices on stocks at the same time. An auction market exclusively deals with stocks. That means many forms of auctions, like those for rare artworks, have no place in auction markets. The New York Stock Exchange is the most prominent example of an auction market. In an auction market, it is not just the highest bid that mattress. The buyer’s bid and the seller’s price must match to execute a trade. While there are several advantages to auction markets, finding the right match can be difficult. The price at which a particular stock is trading also shows that it is the highest price that buyers were willing to pay and the lowest amount that is acceptable to the seller.
While over the counter (OTC) trades have room for negotiations, nothing like that is available for auction markets. Here buyers and sellers do not negotiate with each other directly. An auction market is different from a dealer market. In the latter, dealers do the buying and selling on behalf of their clients. The task of an auction market is not to facilitate trades between different parties. It only concerns matching the buyers with sellers and vice versa. Despite having a fundamental difference, many people get confused between auction markets and dealer markets.
There is also another type of auction which happens at the government level. In the United States, for example, The United States Treasury holds auctions where both retailers and institutions can participate. These bids are both competitive and non-competitive. The non-competitive bids are usually meant for retailers while more powerful financial institutions participate in the competitive bids. Now that we know what an auction market is, let us look at how the process of auctioning works in an auction market.
How does an Auction Take Place?
Depending on the type of auction, there are several ways for auctions to take place. Typically, the highest bidder is the winner in an auction. However, in an auction market, it is the matching of the prices that makes more difference. Let us take an example of both types.
Take for example that one of the newly discovered paintings of Leonardo Da Vinci is up for sale. The organization (government or museums, or individuals) set a base price for the painting at the beginning of the auction. From there, bidders bid on any amount that is higher than the base price. Say the base price is $50,000. From there, the first bid is for $60,000, the second for $65,000, etc. If no one is willing to pay more than $65,000, that becomes the winning bid. The process continues until there is no one left to make a higher bid.
Auctions look a little different in an auction market. For example, four bidders can put prices of $11, $12, $13, and $14 for a share of a given company. On the other end, let us assume the seller puts up the price of four stocks as $14, $15, $16, and $17. Here, only one buying price and selling price is matching - $14. The order for that amount is immediately executed, the company’s share is said to be trading at $14. The other bids are kept on standby.
All auctions follow roughly the same process to sell or buy an asset.
What Are the Types of Auctions? (With Examples)
As we have repeatedly said, there are diverse types of auctions. Now we will look at the different types of auctions and see how they differ from one another.
The most common type of auction is also known as an Absolute Auction. In an absolute auction, there are no complexities of rules. It follows a simple formula of declaring the highest bid as the winning bid. Absolute bidding generally gets the seller the highest price for their asset.
At the same time, absolute auctions are also the riskiest type of auctions from a seller’s perspective. That is because the seller does not have the right to dismiss the winning bid, even if it is far lower than what they expected. At the same time, if the person making the winning bidder defaults on the amount, the entire process has to be conducted again. There is no room for introspection or background checks in an absolute auction.
A Minimum Bid Auction is quite like an absolute auction. The highest bid is the winner here as well. However, there is a key difference. The seller sets a minimum bid, from where the auction starts. It is safer for the seller since they will not get a price that is far below their expectations. At the same time, it is a tad bit more undesirable for buyers than absolute auctions.
In a Reserve Auction, the seller has the right to dismiss the winning bid for whatsoever reason. While it guarantees a much higher level of safety for the seller, it is far less attractive for the buyers.
Sealed Bid Auctions refer to those auctions where buyers do not know what others are bidding. They send their highest bids in a sealed envelope to the seller. Sealed Bid Auctions are good for properties, where a low absolute bid can take down the property’s market price. The seller has a lot of control over the process as well. For buyers, it may not be the most desirable method.
A Two-step Auction is a combination of a sealed-bid auction and an absolute auction. Typically, the seller invites the top five or ten bidders for a live auction if the highest sealed bid is not acceptable. Then they compete against each other for the asset in an absolute auction.
While there are so many types of auctions, their core properties are the same. In each process (barring a few exceptions), the highest bidder is the winner. While sellers have more security in some processes, buyers have an edge in others. Overall, auctions try to guarantee the best price for both the buyer and seller.
What Is Forex Auction?
Forex auctions are a special type of auctions where instead of any asset, foreign currencies are at stake. In Foreign Exchange Auctions, the central bank sells foreign currency periodically through a bidding process and buys foreign currency in the interceding periods at the rate set by the last auction. It is critical to consider the exchange auction from the perspective of the various alternative exchange rate systems that are used to settle a currency crisis and re-establish a reserve buffer.
The purpose of forex auctions is to maintain the reserve of foreign currencies. Foreign currencies also function as investment instruments, particularly in places where inflation rates are very high. It is also a tool for the national banks to play a key role in the process through which foreign currencies enter and leave a country.
While forex auctions are quite different from auctions through which houses or other physical items are sold and brought, they also follow the same fundamental principles. However, access and entry to it are much more restricted.
Conclusion
Auctions have been present in human societies for a long time. Everything from other humans to animals to lands was auctioned at a time. It has always been a tool through which buyers and sellers can find a common ground in terms of price and asset. Today there are various types of auctions, from rudimentary agricultural auctions to more sophisticated forex auctions. Despite their differences, different types of auctions share a lot of similarities. Our goal in this article was to familiarise you with the process and untangle the related confusion. We hope this piece will help you understand what an auction is and how you can participate in one.
Frequently Asked Questions (FAQs)
How can I participate in the auction market?
In the context of forex auction, it is an exclusive market where only members of the exchange can bid on shares that are short delivered. There are specific windows for the auction market. Exchanges do this to make sure that there is not any conflict of interest.
If you are an individual, you must first be a member of some exchange to participate in the auction market.
For other types of auctions, it depends on who is organizing the auction and what their entry policies are. In certain informal agricultural markets, anyone can bid in an auction. In most cases, anyone can take part in an absolute auction.
What is the difference between the auction market and dealer market?
To put it simply, a dealer does the buying and trading for clients in the dealer market, but the auction market’s work is to match buyers and sellers. Dealers have a very restricted role in the auction market. On the other hand, multiple dealers buy and sell assets on the dealer market, with the retailer playing no role.
Is OTC an auction market?
Over the counter (OTC) trading means that the stock is not auctioned. Individual firms claim to be "market-makers" for the stock. By buying the stock from shareholders, these brokerage firms mark it up and sell it. Market-makers pay the bid price for your shares when they are willing to buy them.
How does a currency auction work?
A currency auction, or foreign currency auction to be specific, is an auction for foreign currencies that happens when a currency’s demand is higher than its supply. It is a process through which the central banks trade with the forex exchanges.
What happens if no one bids at an auction?
Vendors would often set token bids to get the wheels rolling. Depending on the type of auction, different things can happen if no one bids at an auction. In the case of mortgage companies, they would be the bidders in the case of no auction and retain the property. It is extremely rare for such a thing to happen in real situations.