The principle of price discovery in stock markets refers to the process through which the fair market price of a security is determined based on supply and demand. It reflects how buyers and sellers interact in the market, expressing their expectations, risk tolerance, and information through bids and offers. When many participants compete to buy and sell, the stock exchange acts as a platform that matches orders, allowing the current price to represent the consensus value of that asset at a given moment.

Price discovery is not just about numbers; it incorporates investor sentiment, company performance, macroeconomic factors, and even global events. For instance, strong earnings or positive economic data may increase demand for a stock, pushing its price higher. Conversely, negative news or weak financials can lower demand and bring prices down.

The process is dynamic, meaning prices constantly adjust as new information enters the market. Transparency, liquidity, and efficiency are essential for effective price discovery because they ensure that all participants can access the same information and trade fairly.

Understanding price discovery is vital for investors because it provides insight into whether a stock is overvalued, undervalued, or fairly priced. It helps them make better trading decisions, manage risk, and participate in markets more confidently.