The Roles Of Traders And Investors In The Marketplace

July 11 2012

Many people use the words "trading" and "investing" interchangeably when, in reality, they are two very different activities. While both traders and investors participate in the same marketplace, they perform two very different tasks using very different strategies. Both of these parties are necessary, however, for the market to function smoothly. This article will take a look at both parties and the strategies that they use to make a profit in the marketplace.

SEE: Passive Vs. Active Management

What Is an Investor?An investor is the market participant that the general public most often associates with the stock market. Investors are those who purchase shares of a company for the long term with the belief that the company has strong future prospects. Investors typically concern themselves with two things:

• Value - Investors must consider whether a company's shares represent a good value. For example, if two similar companies are trading at different earnings multiples, the lower one might be the better value because it suggests that the investor will need to pay less for $1 of earnings when investing in Company A relative to what would be needed to gain exposure to $1 of earnings in Company B.
• Success - Investors must measure the company's future success by looking at its financial strength and evaluating its future cash flows. 

Both of these factors can be determined through the analysis of the company's financial statements along with a look at industry trends that may define future growth prospects. At a basic level, investors can measure the current value of a company relative to its future growth possibilities by looking at metrics such as the PEG ratio- that is, the company's P/E (value) to growth (success) ratio.

SEE: PEG Ratio Nails Down Value Stocks

Who Are the Major Investors?There are many different investors that are active in the marketplace. In fact, the vast majority of the money that is at work in the markets belongs to investors (not to be confused with the amount of dollars traded per day, which is a record held by the traders). Major investors include:

• Investment Banks - Investment banks are the organizations that assist companies in going public and raising money. This often involves holding at least a portion of the securities over the long term.
• Mutual Funds - Many individuals keep their money in mutual funds, which make long-term investments in companies that meet specific criteria. Mutual funds are required by law to act as investors, not traders.
• Institutional Investors - These are large organizations or persons that hold large stakes in companies. Institutional investors often include company insiders, competitors hedging themselves and special opportunity investors.
• Retail Investors - Retail investors are individuals that invest in the stock market for their personal accounts. At first, the influence of retail traders may seem small, but as time passes more people are taking control of their portfolios and, as a result, the influence of this group is increasing. 

SEE: Institutional Investors And Fundamentals: What's The Link?

All of these parties are looking to hold positions for the long term in an effort to stick with the company while continuing to be successful. Warren Buffett's success is a testament to the viability of this strategy.

What Is a Trader?Traders are market participants who purchase shares in a company with a focus on the market itself rather than the company's fundamentals. Markets that trade commodities lend themselves well to traders. After all, very few people purchase wheat because of its fundamental quality - they do so to take advantage of small price movements that occur as a result of supply and demand. Traders typically concern themselves with:

• Price Patterns - Traders will look at the price history in an attempt to predict future price movements, which is known as technical analysis.
• Supply and Demand - Traders keep close watch on their trades intraday to see where the money is moving and why.
• Market Emotion - Traders play on the fears of investors through techniques like fading, where they will bet against the crowd after a large move takes place.
• Client Services - Market makers (one of the largest types of traders) are actually hired by their clients to provide liquidity through rapid trading. 

Ultimately, it is traders that provide the liquidity for investors and always take the other end of their trades. Whether it is through market making or fading, traders are a necessary part of the marketplace.

SEE: What Can Traders Learn From Investors?

Who Are the Major Traders?When it comes to volume, traders have investors beat by a long shot. There are many different types of traders that can trade as often as every few seconds. Among the most popular types of traders are:

• Investment Banks - The shares that are not kept for long-term investment are sold. During the initial public offering process, investment banks are responsible for selling the company's stock in the open market through trading.
• Market Makers - These are groups responsible for providing liquidity in the marketplace. Profit is made through the bid-ask spread along with fees charged to the clients. Ultimately, this group provides liquidity for all the marketplaces.
• Arbitrage Funds - Arbitrage funds are the groups that quickly move in on market inefficiencies. For example, shortly after a merger is announced, stocks always quickly move to the new buyout price minus the risk premium. These trades are executed by arbitrage funds.
• Proprietary Traders/Firms - Proprietary traders are hired by firms to make money through short-term trading. They use proprietary trading systems and other techniques in an attempt to make more money by compounding the short-term gains than can be made by long-term investing. 

The Bottom LineClearly, both traders and investors are necessary in order for a market to function properly. Without traders, investors would have no liquidity through which to buy and sell shares. Without investors, traders would have no basis from which to buy and sell. Combined, the two groups form the financial markets as we know them today.

Read more: http://www.investopedia.com/articles/basics/07/trading_investing.asp#ixzz20KcDub4Q

THERE are many different types of investors. Here are 10. Maybe you can spot yourself.

Many types make up the world of share trading
June 26, 2010

THERE are many different types of investors. Here are 10. Maybe you can spot yourself.

The Plodder This is your goody two-shoes investor. Holds a portfolio of long-term stocks. Out of 20 stocks bought for $50,000 each, all are worth $60,000 except for Telstra ($30,000) and the banks ($100,000 each). Carved out of the annals of financial theory. Focuses on franking. Quotes Warren Buffet.

Banks are 40 per cent of the portfolio because he got them in the float and never sold them. Never trades. Never sells. Is appropriately inattentive. Wishes he'd sold Telstra.

The fear of losing money to the Tax Office through capital gains has driven spectacular long-term annual compound returns and ensured an absolute belting in the global financial crisis.

But it doesn't matter because everything was bought for 10¢. Will leave millions to his undeserving children, who will cash it all in and live like kings.

The Gambler Thinks the sharemarket is everything the product marketers say it is and is quickly skinned alive in some derivative product he didn't understand.

The 10-Bet Investor Has 20 stocks bought for $50,000 each. Two stocks have gone to zero. Sixteen are worth between $45,000 and $55,000. One stock is worth $200,000. One stock is worth $2 million. Focus on resources exploration, biotechs and new issues. No banks. No big blue chips. No yield. This is organised gambling where the odds are narrowed by a lot of work, information and networking.

The "Blind and in Love" Investor Has $1 million and it is all in one stock. Next year it will be worth anything between zero and $10 million. This is the investor who knows absolutely everything about a stock of which you've never heard.

Is in the top 20 shareholders. The first holding cost less than a cent. Loses more than your mortgage on a 1¢ move and it moves 2¢ a day.

Doesn't sell on the spikes. Doesn't sell on the troughs. This is long-term, high-risk investment, but they know all the risks. Talks about the stock, and is very rich, or very poor. They ring you up when they're 60 either to (a) borrow money or (b) invite you to join them in the Bahamas.

The Day Trader If he has $1000 he has one stock worth $100,000, but he has to sell by the end of the day. Pays the average salary in dealing costs every year. High attrition rate. Only the devoted survive.

The Income Investor Through necessity or tradition is investing in equities for income. Made huge losses in the financial crisis having never sold "as long as they still pay the dividend". Has now learnt that $1 of income is exactly the same as $1 of capital, especially when it is a capital loss.

Hates the volatility. Wishes things would "just go back to the way they were". Is now thinking that 5 per cent in bonds isn't bad just so long as you can sleep at night.

The Value Investor Makes long-term declarations about stocks based on historic information and grand assumptions. Can explain everything but cannot trade and is useless at timing. Needs 50 years to prove he is right. Usually is.

The Lone Ranger An amateur trader who has given up his day job to trade the sharemarket. Will survive until he runs out of money or wakes up to the fact that trying to make $1000 a day out of necessity, even if successful, is a difficult, tough, demanding, soulless and ultimately boring existence.

The One-Stock Trader Has worked out that diversification is for people who don't know what they're doing and a lot more risky that trading one stock again and again and again. Does it quite well. Is vulnerable to once-in-a-lifetime events that seem to happen once a year.

The ETF Trader After many years trying to trade stocks has finally realised that his nirvana is trading the market through an index ETF. No need to read any research about stocks. No need to read 99 per cent of the business section.

All that matters is timing the market, which he does through vigilance and a combination of technical and fundamental "feel". He is relaxed. Has realistic expectations and trades just five times a year.

Who did I miss?

Marcus Padley is a stockbroker with Patersons Securities and the author of the daily stockmarket newsletter Marcus Today. For a free trial of the Marcus Today newsletter please go to marcustoday.com.au

Source: The Age