Information signalling

A share's price is not just a number to trade at. Every time it moves, it is telling everyone something.

That is information signalling. As investors buy and sell based on what they know or believe about a company, the resulting price captures the market's collective judgement — good news pushes more buyers in and the price up; bad news does the reverse.

Because this happens continuously, it works like a constant monitor sitting over every listed company, quietly pressuring it to actually perform, not just to have performed well once.

Information signalling is 1 of 4 functions of the secondary market the workbook lists, alongside liquidity, price discovery, and indicating wider economic activity. In an efficient market, prices are meant to reflect all available information — a large number of buyers and sellers acting on that information creates short-term price volatility, but also efficiently folds new information into the price as it becomes known.

This is closely linked to, but distinct from, price discovery: price discovery is about the market establishing what a security is currently worth; information signalling is about that same continuous price movement communicating fresh information to everyone watching, forcing issuers to respond to how the market is judging them.

A listed company reports weaker-than-expected quarterly profit. In the days that follow, more investors try to sell the stock than buy it, and its price falls from Rs 500 to Rs 420, a 16% drop. That fall is information signalling at work: the market is telling every other participant, instantly and publicly, that something about this company's prospects has worsened, without anyone needing to read the full result themselves.

The company's management, watching its own falling share price, comes under pressure to explain the miss and show a credible plan to improve, the continuous-monitor effect the workbook describes, operating entirely through the price itself.

Chapter 6 (Securities Market Segments), section 6.2.1 (Information Signalling), describes this as one of the secondary market's core functions, right after price discovery and before the market's role in indicating wider economic activity. Expect a question naming information signalling as a secondary-market function, or one distinguishing it from price discovery.

• Information signalling and price discovery are related but distinct functions — price discovery finds what a security is worth right now; information signalling is the ongoing communication of new information through price movement.
• Volatility from many traders acting on information is not a market failure — the workbook frames it as part of how markets efficiently incorporate new information, not a defect.
• This function depends on the market being reasonably efficient, prices actually reflecting available information, for the signal to be meaningful at all.