Types of Market Players

There are different trading markets where you will encounter several types of players. To determine your own role in trading, you will need to learn more about the various participants in the market and their specific features.

The most popular trading markets include stocks, bonds, forex, options and derivatives, and physical assets. Each of these markets has specific players that belong to different categories according to the type of trading that they practice. Many of the trading players can be seen in more than one type of market, which is why it is important to know the different kinds of trading agents you will be facing when engaging in any type of trading.

Derivative Market

This market is reserved for trading in specific financial instruments, collectively known as derivatives. Swaps, contracts for difference, forwards, futures, and options all belong to this category. When trading with such products, traders are not necessarily required to own or purchase any underlying assets.

Derivatives are essentially special types of contracts whose value is “derived” from the value of a given underlying entity, hence the name. This can be a stock index, an individual stock, an asset, a bond, a commodity, or even a currency pair. Derivatives are commonly used as a way to reduce risk (hedging), insure against it, or assume it for the chance to earn commensurate gains (speculation).

Derivatives can be grouped into two main categories – lock and option products. Forwards, swaps, and futures are all lock derivative products where the parties involved are bound by pre-established terms over the derivative contract’s lifespan. Options, like stock options, for instance, grant holders the right to purchase or sell securities or underlying assets at a specified price before the option expires.

However, the holder is by no means obliged to sell or buy on or before said expiration date. Such financial instruments are significantly trickier and as such, are mainly used by more advanced traders.

As derivative contracts are bought by retail and institutional players with varied needs, market participants are defined by the purpose for which they choose to trade in derivatives. The important players in the derivatives market are hedgers, speculators, and arbitrageurs.

Hedgers

We could say that ‘’hedging’’ simply means a reduction of risk, enclosing a position in order to restrain it from risky factors or influences coming from the current market situation. An investor who is pursuing a reduction of risk is known as a hedger. A hedger strives to reduce their asset exposure to price volatility. In a derivative market, hedgers would take up a position that is opposite to the risk they are exposed to. Hedgers use different derivative strategies in order to reduce or eliminate price risk.

For example, an investor intends to purchase 1,000 shares of company ‘’ABC’’, but also wants to ensure this long position against the market trend, especially in times of high volatility. Consequently, they should take a short position of the same amount of ‘’ABC’’ futures to form a hedge. Such action would reduce their exposure to unfavorable situations or events whose influence reflects upon the whole market.

Let us give a simple example. If the spot market price of shares drops (presumably, you are holding a long position in these shares), the loss you realized from shares could be compensated by the profit you achieved with the short position in a derivative instrument (futures, for example).

Every hedger makes transactions today in the futures market, where prices are known, while the results of these transactions are expected to appear tomorrow in the spot market, where prices are still unknown. Let us give another example. A farmer produces 25,000 lbs of pork and would like to sell it on February 25th.

The spot price for pork is 1.50 USD for 1 lb. The futures price on February 25th is 1.55 USD for 1 lb. What action would the farmer take if there were concerns that the price would be lower until February 25th? Or what price would they lock in? In this case, the farmer would take a short position in 1 futures contract with a February maturity. The futures price would be 1.55 USD/lb.

• 1st scenario: on February 25th, the spot price for pork declines to 1.45 USD/lb. The farmer sells pork for: $1.45/lb * 25,000 lb = $36,250. Then they back the futures contract with a profit of ($1.55 – $1.45) * 25 000 = $2,500. The total profit amounts to 36,250 + 2,500 = $38,750.
• 2nd scenario: on February 25th, the spot price for pork increases to 1.60 USD/lb. The farmer sells pork for: $1.60/lb * 25,000 lb = $40,000. Then he buys back the futures contract with a loss of ($1.55 – $1.60)* 25,000 = – $1,250. The total profit amounts to 40,000 – 1,250 = $38,750.

Speculators

Speculators hypothesize expected price movements and take accordant positions to maximize their gains. These are risk-takers – their affinity to risk is much higher than that of a risk-averse investor. They participate in the derivative markets merely for the purpose of profit-making.

They need to effectively make predictions for future market trends in order to take positions. Such behavior does not in any way guarantee them the safety of the capital they invested or any returns. Speculators rely on fast-moving trends to forecast possible market moves. In this case, they use technical analysis methodology alongside fundamentals.

The latter could range from changing consumer sentiment and expectations to fluctuating interest rates, retail sales or wholesale indicators, consumer price indexes, gross domestic product for a country/region, or just a single public statement by experts, CEOs, presidents of prestigious and internationally renowned corporations and institutions.

Speculators can make huge profits or an equally huge losses and are typically high net investors, who strive to diversify their positions and always pursue profit maximization in a short period of time.

For example, if a speculator believes the share price of “ABC” is expected to decrease in three-days time given some upcoming market developments, they would usually go short with these shares (i.e. selling them) in a derivative market. The speculator is not necessarily in possession of the shares.

If the stock price falls as expected, they will make a sizable profit depending on the quantity number of shares they hold. However, if the stock price rises, contrary to expectations, the speculator will make a commensurable loss.

Margin Traders

Some speculators also make use of margin trading. This type of trader pays only a fraction of the whole value of their position in derivative trading. This fraction is known as margin, hence, the name of this type of market player. Since you are required to deposit only the margin instead of the entire amount, high leverage is a specific factor of margin trading with derivatives.

Thanks to this type of trading, speculators have the opportunity to actually buy triple or even higher the actual amount they can afford. The finalization of the trade is known as a settlement as the trader either pays the borrowed money to the broker as collateral or makes an opposing trade that will nullify the same amount.

You can take as an example a situation where you can afford to purchase 180 shares in a company and the margin trading in the derivatives market will allow you to buy shares with a margin amount of 30% of your initial outstanding position.

In this case, you will actually have the chance to purchase 600 shares in this company, without spending any extra amount. If the share price rises, you might be able to restore the sum you have borrowed from the broker and even earn a generous profit.

Arbitrageurs

Arbitrageurs play in an extremely fast-paced environment with decisions being made at the blink of an eye, literally. Sometimes the price of a share in the cash market is lower or higher than it should be, compared to its price in the derivative market. Arbitrageurs exploit these imperfections and inefficiencies to their advantage.

They also play an important role in increasing liquidity in the market. An arbitrage opportunity is available, if an investor suffers no costs, regarding purchasing or organizing a certain position in derivative instruments, always realizes positive gains, and takes no risk. These three characteristics must be present simultaneously. Usually, arbitrage opportunities appear for a very limited time, after which they vaporize instantly.

There are various arbitrage opportunities that can be explored. Cash-futures arbitrage is one of the simplest forms. If the futures price is trading at a premium to its base asset, it is referred to as contango. If the premium post adjustment for transaction costs gives higher returns than the cost of capital, an arbitrageur will take positions to benefit from this opportunity. If the futures price is at a discount to its base asset, the situation is referred to as “backwardation”.

Forex Market

While forex trading used to be exclusive to big players, with the innovations that came along with the Internet, regular traders have also become a part of the forex trading market. There are several major players in this trading market and each one of them resorts to a specific type of trading.

Major Banks

Since the Forex spot market is decentralized, determining the exchange rates is the task of the largest banking institutions across the world. The bid/ask spread is based on the supply and demand for the currencies that are most commonly traded.

Collectively, these super banks are known as the interbank market. They engage in numerous forex transactions every day. These major banks are also known as flow monsters. Some of the most popular ones include JPMorgan, Deutsche Bank, UBS, Goldman Sachs, HSBC, and Barclays, among others.

When it comes to their work policies, each superbank follows a different type of strategy. One thing they have in common, however, are their dealing desks. This type of tool has a major role in the profit-making achieved through hedging, arbitrage, or a mixture of trading strategies.

Central Banks

Central banks are usually managed by the government since they play a major role in facilitating the monetary policy of a country. Central banks also smooth out the fluctuations in the value of their currencies, which explains why these institutions are key players in the forex market.

The effect that central banks have on foreign exchange is expressed in their adjustments to the interest rates that are supposed to control the inflation level. There are also cases when central banks participate in forex trading directly to alter exchange rates. This is done when central banks believe their currency is undervalued or overvalued. They start buying or selling to realign the exchange rates.

Major Companies

Even though commercial companies do not determine directly the exchange rates, they are still key agents of the trading market. Whenever there is a merger between companies or there is an acquisition, often this may cause a fluctuation in currency exchange rates. When mergers or acquisitions between international companies occur, this might force prices to move up and down.

You can take as an example a large US company like Apple that has to exchange US dollars for Japanese yen whenever it is closing a deal with a Japanese company for its electronic parts. Of course, since the amount commercial companies are trading is significantly lower than the volume traded in the interbank market, such players tend to work with smaller commercial banks.

Sovereign Wealth Funds, Hedge Funds, Fund Managers

These are all key players in the forex trading market, even though they do not play a role in determining the prices or have any control over them. These are considered money managers that can often handle large sums of money as they tend to have portfolios with numerous investment funds.

Such market players take upon the role of managing trading activities for their investors. The main goal of hedge funds is to gain profits and expand their portfolios, while fund managers choose a trading strategy and oversee mutual funds. In most cases, fund managers trade on the behalf of their investors.

Sovereign Wealth Funds are typically state-owned investment funds, with most of them trading stocks, bonds, precious metals, or other financial assets. In recent years, wealth funds that are sponsored by the government have become very popular as they allow countries to diversify their money by investing in different assets.

Most Common Types of Traders

When you trade different types of financial assets, you will often come across several types of traders, based on their trading style and the strategy they rely on. Each type requires a specific approach. Whether you prefer the dynamics of day-time trading or long-term position trading, choosing the approach that best suits you is of utmost importance for your chances of success.

Noise Traders

The typical characteristic of noise traders is that they do not base their decisions on any sound fundamental or technical analysis. Instead, they tend to be impulsive and irrational when trading. This type of market player is often defined as risky traders (some even call them idiot traders) as they most often prefer to mimic the decisions of other participants, even when the strategy in use is not the best one.

It is typical for noise traders to base their decisions on rumors or insufficient and unreliable data, which leads to erratic and irrational trading behavior. This is one approach you should refrain from adopting due to its high risk and long-term inefficiency. What is more, noise traders often harm the market by causing artificial reactions to their nonsensical trades.

Such herding behavior can lead to massive price fluctuations in one direction or another, regardless of the fact other participants in the market make rational and solid decisions. Noise trading is often associated with high-volume trading periods.

One prime example of the damages noise traders can inflict can be drawn from 2007, a year that saw a rise in self-directed trading activities. Housing market trading skyrocketed to such an extent that it led to the subprime mortgage crash of 2008.

Another example of noise traders driving the markets forward only to see them crash subsequently is the dot-com bubble of the late 1990s. Excessive investment in internet startup companies caused the Nasdaq Index to grow five-fold between 1995 and 2000 only to tumble by nearly 77% from its peak toward the end of 2002. As a result, investors suffered massive losses while numerous internet-based companies went bust, with Priceline, Amazon, and eBay being among the few survivors.

The trouble is a considerable part of the trading community consists of noise investors, even more so now when online brokers make trading readily accessible to everyone with some funds to spare and an internet connection. Figures released by the US Bureau of Labor Statistics indicate there are approximately 2.8 million professional investors as opposed to the 50 million non-professionals, many of whom induce noise in the markets.

Scalper Traders

Scalpers comprise another category of traders whose strategy requires them to open and close positions very quickly. It is typical for such people to use significant leverage. Their purpose is to inflate the size of their positions in the hope of realizing nominal but consistent profits from relatively small movements in the prices.

A scalper would often terminate a position several seconds after opening it. This process is repeated on multiple occasions throughout the day, which is why many scalpers prefer to automate it with the help of software. The scalping style is not suitable for everyone, though.

Discipline is the most distinctive trait of a successful scalper and so is effortless decision-making. Decisions are often made in a split second so that good opportunities are never missed. Discipline comes in the form of setting daily loss limits, which prevents scalpers from loss-chasing.

Swing Traders

Another category of traders comprises the so-called swingers who normally rely on technical analysis and close their positions after several days or weeks rather than holding them for a single day only, as is the case with people who implement day-trading strategies. Some swinger traders would also incorporate fundamentals into their strategies in addition to technical analysis.

Another common trait of swingers is that they usually go long whenever the markets start to show an upward trend and shorten their positions whenever price swings end. Timing is essential for traders who belong to this category. The main focus here is capitalizing on short-term price fluctuations. Common traits inherent to swing traders are patience, emotional control, and composure.

Position Traders

Those who belong to the category of position traders typically hold their positions for extended periods of time, i.e. several months and sometimes years. Such traders are less worried about short-term price movements and news releases during any given day unless they affect their long-term expectation.

They watch closely for trends and follow them. Once they spot a potentially profitable trend, they would buy and hold a position until the trend reaches its peak. The ability to adequately identify the best entry and exit prices is essential for them.

Position traders normally rely on fundamentals so they keep their eyes peeled for important announcements and events like mergers, acquisitions, quarterly revenue reports, and company reorganizations.

Some position traders prefer to use fundamentals in combination with technical analysis. This approach to trading is mostly suitable for those who lack time and already have a regular job because it does not require you to invest that much time. Stop-loss orders are typically implemented as safeguards.

Day Traders

This type of trader is the polar opposite of position traders. This style is similar to scalping since the approach involves opening multiple short and long positions to take advantage of the price movements on the intraday market timeframe.

This is why day trading differs from scalping where the timeframes are significantly shorter and decisions are made on one to five-minute charts. Compared to scalpers, day traders do not open as many positions within the same day. Such traders normally set up no more than several trades per day and never leave them open overnight.

Successful day traders are skilled and very competent about the markets they operate on. Such people quickly adapt to price movements and implement common day-trading techniques like fading the gap.

They often prefer to pair more volatile currency pairs like GBP/JPY that can show significant fluctuations within a short period. This type of trading is usually deemed suitable for people who seek to trade high volumes.