What is a Trader?

What is a trader?

In general terms, the term trader refers to a person or business who buys and sells goods and/or services with the intention to generate a profit.

The term originates from the verb ‘to trade,’ which was used in the English language since the 1540s. At the time, ‘to trade’ meant ‘to trade a path.’  Since 1793 the term ‘to trade’ obtained the meaning ‘to barter,’, meaning to exchange goods or services for other goods or services without using money. However, in time people started to use the verb to indicate the buying and selling of goods and/or services as well.

Noteworthy, the term trader originally referred to ‘one engaged in commerce,’ meaning a person who makes a living buying products and other goods and selling them at a profit.

A trader may be may an employee of a financial institution, corporation, or brokerage firm, or maybe an individual who trades on his or her own behalf.

A trader is also called a dealer or a merchant.

In the world of finance, a trader buys and sells financial instruments. A financial instrument can be described as a legal monetary contract that can be created, modified, or traded in different financial markets. For instance:

• Stock markets (stock exchanges) in which shares (stock) are traded by stock traders.

• Bond markets, also called debt markets, in which different types of bonds are bought and sold by bond traders.

• Derivatives markets (derivatives exchanges) are financial markets in which derivatives traders deal with derivatives like options, futures contracts, forwards, and swaps.

• Commodity markets, also referred to as commodity exchanges, in which commodities are traded by commodities traders, like:

Metal such as gold and silver.

Energy such as crude oil and products refined from it. For example, natural gas, heating oil, kerosene, and propane.

Agricultural such as corn, wheat, coffee, and live cattle.

• The foreign exchange market, commonly known as the forex market, allows for the trading of a unique type of financial instrument, the currencies of countries. The forex market is a global decentralized market in which forex traders exchange national currencies with one another and trade with forex futures and forex forwards.

What is the difference between a trader and an investor?

Although the terms investor and trader are often used interchangeably, there is a basic difference.

Generally, an investor is investing for the long term in order to gain larger returns. Typically, an investor will buy and hold a financial instrument for an extended period of time.

Conversely, traders take advantage of both falling and rising financial markets which allow them to enter and exit trading positions over shorter periods of time, creating smaller but more frequent profits.

Types of traders in financial markets

One of the methods to categorise traders in financial markets is based on the trading styles they use to trade in financial markets.

The four most common types of traders in financial markets

Based on trading styles, the four most common types of traders who buy and sell instruments in financial markets are: swing traders, position traders, day traders, and scalpers.

Swing traders

Swing traders hold their trading positions (short or long) for longer than a trading session or trading day. Depending on the trend of a financial instrument, they will hold their position for several days, several weeks, or even a couple of months at a time.

The aim of swing trading is to capture the trend of a financial market or a financial instrument, such as a share or currency pair. Swing traders usually buy when a market reflects an upward swing and sell when the price swing ends.

They use indicators in technical analysis, such as candlestick patterns, moving average, and support and resistance levels to execute swing trading.

Pros of swing trading:

• Swing traders are not required to monitor their price charts an entire trading day. Instead, they devote a few hours per day to analyse the trend of a particular financial market or instrument.
• Swing trading allows swing traders to trade and keep another job at the same time.
• Traders can exclusively utilise technical analysis, making the trading process easier and simpler.
• It provides more trading opportunities, generating higher short-term profits.
• Traders are enabled to set trading positions in liquid currency pairs in the forex market.

Cons of swing trading:

• Traders may miss opportunities on big longer-term trends in favour of short-term price moves in markets.
• Trade positions may be subjected to overnight and weekend market risks.
• Unforeseen and sudden market reversals can cause significant losses.

Position traders

Position traders buy and keep financial instruments over longer periods of time, expecting that they will increase in value.

They are more interested in an instrument’s sustained performance and less concerned with short-term price fluctuations.

Position traders do not trade actively and constantly such as day traders. Usually, they place fewer than ten trades per year.

They combine fundamental analysis and technical analysis as their trading strategy, using fundamental analysis as their predominant trading strategy and technical indicators to time their entry trading positions.

Pros of position trading:

• Position trading allows traders to spend lesser time on trading because it involves long-term trading. This enables a trader to spend more than on other aspects of his or her investment portfolio.
• Protects a trader against short-term price fluctuations.
• Offers an encouraging risk-reward ratio.

Cons of position trading:

• Position traders are required to have a thorough knowledge of the aspects of fundamental analysis. This implies that a trader must be aware of economic events and the reactions of financial markets to the events.
• Traders may generate lower profits because of the lower number of trades.
• Traders are required to trade with a larger amount of money due to a wide stop-loss.

Day traders

Day traders are active traders who trade on a daily basis, buying and selling financial instruments within a single trading day. This implies that they close all trading positions at the end of a trading day.

Day trading can be practised in any financial market, but it is most commonly applied in stock markets and in the forex market.

The goal of day traders is to generate profits from relatively short-term price movements. This is achieved by capturing intraday volatility in the prices of financial instruments, using a variety of intraday strategies and techniques available in technical analysis.

Pros of day trading:

• Due to the closing of trading positions at the end of each trading day, day traders are not subjected to overnight risk.
• Day traders who trade regularly, have access to increased leverage and lower commissions.
• Numerous trades enable day traders to increase their hands-on learning experience.

Cons of day trading:

• Numerous trades imply multiple commission expenses.
• Losses can escalate quickly, especially if leverage is involved.
• Opportunities to generate profits may disappear due to insufficient time for a favourable trading position to create a profit before it has to be closed out.

Scalping

In scalping, also called micro-trading, a scalper executes numerous trades (ranging from dozens to hundreds) during a trading day, aiming to make small profits at the busiest times.

Scalping is mostly practised by day traders in stock markets and the currency market. For example, the main goal of a scalper in the forex market is to secure significantly tiny amounts of pips as many times as possible during the busiest times of a trading day.

Currency pairs in forex are quoted in pips, short for percentage in points, which is one-hundredth of one percent, expressed as 0.0001.

Pros of scalping:

• Provides daily plenty of trading opportunities to leverage small movements in the price of a share or currency pairs.
• Knowledge of basic fundamentals is not necessary.
• Minimum market risk
• When executed accurately and combined with an exact exit strategy, scalping can be very profitable.

Cons of scalping:

• High transaction costs can reduce profits.
• Higher leverage is required to generate profits.
• Can be time-consuming, requiring long hours of a trading day to monitor price charts as well as high levels of concentration.

Other types of traders in financial markets

In addition to the four common types of traders explained above, the following types of traders can also be mentioned:

• An algorithmic trader uses a computer program that follows a defined set of rules, referred to as a trading algorithm (algo) to open and close trades at the best possible prices.

Algorithmic trading is also called algo-trading, black-box trading, or automated trading.

• Momentum traders use momentum trading, which is a practice to buy and sell financial instruments according to the recent strength of price movements.

Momentum traders assume that if there is enough strength behind a price movement, it will continue to proceed in the same direction. They use technical indicators to recognise the direction of a market trend, aiming to catch the momentum of the trend and generate profits from it.

Momentum traders are also called trend traders.

• Breakout traders look for opportunities when prices of financial instruments breakthrough levels of support or resistance. When a breakout occurs, it needs to be accompanied by increased volume to be considered a genuine breakout.

Breakout traders may use a genuine breakout as an opportunity to buy or sell a given financial instrument.

• Range traders tend to buy and sell financial instruments in a specific trading range.

A trading range occurs when a financial instrument, such as a security or commodity, moves consistently between two prices or price levels for a given period of time. For instance, a company’s share price moves between R100 and R110.

Range trading involves buying and selling a financial instrument over a short period of time.

• Contrarian traders use a trading style, called contrarian trading, in which they purposefully trade against prevailing market trends by selling financial instruments when other traders or investors are buying, and vice versa.

Different types of traders described in broader terms

Besides trading styles, traders can also be categorised in broader terms, such as sentiment traders, noise traders, market timers, and fundamental traders.

Sentiment traders

Sentiment traders combine various aspects of fundamental analysis and technical analysis with market sentiment in order to identify and participate in market trends, fine-tuning entry, and exit signals.

They use sentiment trading, also called sentiment analysis, as a trading strategy to determine when to buy or sell a given financial instrument.

Market sentiment refers to the mood of financial markets and the overall feeling among traders toward a given financial instrument, such as a company share or currency of a country.

Understanding market sentiment enables traders to decide whether a financial market has:

• a positive or optimistic mood, representing increasing prices, referred to as a bullish market, or
• a negative or pessimistic outlook, indicating falling prices, called a bearish market.

Two common examples of sentiment traders are contrarian traders and swing traders.

Noise traders

Noise traders practise a style of trading characterised by irrational, impulsive decisions, mostly driven by fear and greed.

Typically, noise traders are unskilled, uninformed, and undisciplined. They mostly follow trends and emulate the actions of other online traders.

Investopedia describes noise traders as ‘largely uninformed traders who trade on the noise in the market instead of the signal.’

Market timers

Market timers use market timing as a trading strategy that involves the buying or selling of financial assets by predicting their price movements in the future.

Market timing allows traders to beat the market by placing a long position (buying) at market lows and a short position (selling) at market highs.

The timely buying and selling of financial instruments are based on expected price fluctuations and are guided by predictive methods such as fundamental and technical analysis techniques.

Fundamental traders

Fundamental traders are convinced that a financial market will react to specific events in the economy (local or global) in predictable ways.

When using fundamental analysis, a trader researches aspects of the overall state of the economy of a country and the world, concentrating on aspects closely related to his or her trade. Aspects of interest can be political, social, and general.

This article does not intend to provide investment or trading advice. Its aim is only informative.