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types of traders -
March 13th, 2007
Types of Traders - ScalpingBy Jason Van BergenContact Jason August 19th, 2002
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One of the most confusing aspects of the trading profession is there is no single definition of “trader.” Traders come in many different shapes and sizes, colors, and varieties. Traders generally focus on a specific class of security, mostly common stocks, but they may also trade equity options, commodity futures, financial futures, futures options, bonds, foreign markets, and so forth. The type of security of choice also dictates the specific market(s) on which they trade – NYSE or Nasdaq, Chicago Board Options Exchange, The Chicago Board of Trade, and so on.
When trading common stocks, professionals will generally undertake one of several styles and stick only to that style. This is an important point since traders are always at the risk of being distracted by the din of ubiquitous market commentary and confliciting trading styles. Traders are constantly soul-searching and questioning their own chosen approach. Some amount of experimentation is advisable, particularly at the beginning of your trading career, but deviating from a disciplined, focused approach can be disastrous once you've found your niche.
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Some of the first decisions you will make will determine where your niche is and what type of a trader you want to be. There are at least five distinct styles of common-stock trading, each completely unrelated the others. The style that you choose will likely reflect your intellectual strengths, your understanding of various aspects of the markets' operations, and your temperament.
The major styles of equity trading are as follows:
1) Scalping - The scalper is an individual who makes dozens or hundreds of trades per day, thereby “scalping” a small profit from each trade by exploiting the bid-ask spread.2) Momentum Trading - Momentum traders look to find stocks that are moving significantly in one direction on high volume and try to “jump on board” to ride the momentum train to a desired profit.3) Technicians - Technical traders are obsessed with charts and graphs, watching lines on stock or index graphs for signs of convergence or divergence that might indicate buy or sell signals.4) Fundamentalists - Fundamentalists are in no way associated with the Religious Right; instead they trade companies based on fundamental analysis, which examines things like corporate events such as actual or anticipated earnings reports, stock splits, reorganizations, or acquisitions.5) Swing Traders - Swing traders are really fundamental traders who hold their positions longer than a single day. Most fundamentalists are actually swing traders since changes in corporate fundamentals generally require several days or even weeks to produce a price movement sufficient enough for the trader to claim a reasonable profit.
Novice traders might experiment with each of these techniques, but they should ultimately settle on a single niche, matching their investing knowledge and experience with a style to which they feel they can devote further research, education, and practice. Entire textbooks are devoted to each style, although many titles such as Day Trade Online or How to Get Started in Electronic Day Trading are unclear about what type of trading they espouse.
I will devote the balance of this article to scalping. At the risk of disappointing some, I will not be recounting my favorite scenes from The Last of the Mohicans, but I will be describing a trading technique whereby the trader “scalps” small profits by exploiting the spread of a slow-moving stock. In my next column, I will explore momentum trading, followed in the future by technical analysis and swing trading. As always, if you are more interested in one style over another, please let me know--I can easily adjust my columns to reflect the interests of the majority of readers.
The scalper is a type of trader who generates trading profits from stocks that are not moving. Scalpers make tiny (or teenie) profits from each trade by exploiting the bid-ask spread: they buy a stock on the bid then turn around and sell at the ask. Provided that the stock does not move, scalpers can profit all day by making dozens (or hundreds) of trades, buying at the highest price at which they feel comfortable and selling at the lowest price that guarantees sufficient profit while still being attractive to buyers within the market.
The scalpers' role is exactly the same as that of the market maker (also known as the specialist), who is a dealer that, by trading stock from his or her own inventory, maintains an orderly market in any given stock. The specialist is basically a scalper on steroids, as the specialist will trade many times more volume per day than the average scalper. The specialist, however, is bound by strict exchange rules while the individual trader is not. For example, on the Nasdaq all market makers are required to post at least one bid and one ask at some price level, thereby making a two-sided market for each stock that they cover.
Due to the overlap of roles, the scalper is always competing with the market maker for profits. Unfortunately, the lowly scalper is almost always at a disadvantage due to the market maker's advatages: superior execution speed, perhaps a greater knowledge of trading, and the ability to “bluff” the market by placing a bid or ask that exaggerates his or her own true position.
The other factor working against the scalper is decimalization, whereby stock prices that were previously quoted in fractions are now quoted in decimals. With fractions, scalpers were always aiming for at least a sixteenth of a point in profit, also known as a teenie, equating to 6.25 cents per share. On a 1,000 share trade, for example, buying a stock at 10 and selling it at 10 1/16, a scalper would generate $62.50 in profits before commissions.
With the advent of decimalization, teenies are now toast, and the difference between bid and ask may be a single penny. On the 1,000 share trade described above, buying at $10.00 and selling at $10.01 would generate only $10.00 in profits, most likely not even enough to cover trading commissions.
This is not to say that scalpers' profits have been entirely scalped. Depending on the stock traded and its liquidity, spreads may remain much higher than a penny, allowing scalpers to generate even more than a teenie. By increasing the number of shares bought and sold (trading 2,000 instead 1,000, for example), scalpers can compensate for any realized decline in spreads, but this comes at the expense of increasing their risk. As for any style of trading, finding a niche from which you can derive profits is your utmost goal. Once you've found that niche, you can refine your technique so that you may be able to successfully trade for pennies just as you were able to trade for teenies.
Until next time, keep your e-mails coming, and, again, please let me know where your interests lie. You may want to know more about scalping, or you might be anxious to learn about the other styles of trading (momentum, technical analysis, fundamental analysis). And if something I've said does not jive with your own experiences in the trenches, don't hesitate to drop a line. I'm always interested to hear about the current techniques that you are employing to maximize trading profits. You don't have to give away your trade secrets (how many puns can one columnist generate?) to share some of your wisdom with the world.
Jason Van Bergen