The Definition of a Trader
A trader is an individual who engages in the buying and selling of assets in any financial market, either for themself or on behalf of another person or institution. The main difference between a trader and an investor is the duration for which the person holds the asset. Investors tend to have a longer-term time horizon, while traders tend to hold assets for much shorter periods to capitalize on short-term trends.
KEY TAKEAWAYS
- Traders are individuals who engage in the short-term buying and selling of a financial asset for themselves or an institution such as a bank, brokerage firm, or hedge fund.
- Traders use a variety of strategies to generate profits, including scalping, day trading, and swing trading.
- Traders can be contrasted with investors, who seek long-term capital gains rather than short-term profits.
The Role of a Trader
The main objective of a trader is to generate profits by buying at a low price and selling at a higher price. What they buy and sell are financial assets that include stocks, bonds, currencies, commodities, and derivatives. The profit generation is achieved through various approaches such as fundamental, technical and quantitative analyses, which aid in identifying market trends and opportunities.1
Traders also manage risks associated with their profession, including market risk, credit risk, and liquidity risk. They may use hedging strategies to mitigate these risks.
Skill Requirements of Traders
Traders need to possess several quantitative and qualitative skills to be successful. The skills are a combination of technical, analytical, and behavioral qualities. It is a prerequisite for traders to be experts of the financial markets.
Traders need to have a deep understanding of the asset classes, market dynamics, and various strategies in these markets. Traders have to be analytical. They need to figure out how to process large amounts of data quickly and correctly to make informed decisions about the financial markets in which they trade. Numeracy skills are also important. Traders have to be able to calculate complex financial problems.1
Traders also need to be masters of risk management. They must constantly monitor their current and potential positions to ensure that the risks they take are optimal. Traders must effectively use their stop-loss and limit orders to maintain profitability and margins.
Communication is also a key skill for a trader. Their colleagues, clients, bosses, and other stakeholders need to quickly and effectively understand what their trader is saying so that they can make informed decisions. Finally, traders should have high emotional intelligence. Trading is an intense profession, and traders need to effectively manage their emotions in a highly stressful environment.
Trading Strategies
Traders employ many strategies to produce and maintain profitability. Some of these strategies include scalping, day trading, swing trading, event trading, and position trading. It should be noted that no trading strategy is foolproof; there are advantages and disadvantages to any trading strategy. Traders also consider risks when employing their strategies.
Scalping
Scalping entails the buying and selling of financial instruments such as stocks, futures, currencies, and commodities in quick succession, with the goal of producing small gains on the positions. Scalpers attempt to profit from short-term price movements. The time frame that scalp traders hold positions ranges from seconds to minutes. The risk in scalping lies in the quick generation of successive losses rather than gains.2
Day Trading
The strategy of day trading involves taking positions in financial assets such as stocks, futures, currencies, and commodities within the same trading day. Day traders tend to hold an abundance of trades over minutes and hours, as they maneuver their transactions through changing market conditions. They tend to amplify their trades through leveraged positions. The use of leverage poses an additional risk for day traders.3
Swing Trading
Swing trading involves profiting from short- to medium-term price movements in various financial instruments such as stocks, futures, currencies, or commodities. Unlike scalpers and day traders, swing traders hold their positions for longer time periods. This can be for several days, weeks, or even months and is dependent on the asset, the trend, and the other existing positions of the swing trader.
Generally, swing trading is considered to be less risky than scalping or day trading because swing traders have more time to make decisions. Nonetheless, there are risks involved. News or events can affect the price trends of the swing trader’s portfolio.4
Event Trading
The strategy of event trading entails profiting from short-term price movements triggered from a specific economic or financial event such as mergers or acquisitions, earnings releases, regulatory decisions, inflation data, labor market data, or gross domestic product (GDP) data.
Event traders need to execute their positions quickly, seconds before the data release, to profit from the position. Also, event traders tend to use leverage to amplify their profits. The use of leverage comes with additional risks to the strategy.5
Position Trading
A position trader or a position trading firm is an individual or entity that buys financial assets for the long term. These professionals hold positions for weeks, months, or even years. The time frame of holding the position is highly dependent on the position trader’s investment thesis as well as the economic and financial market outlook.
With the longer-term view, position trading is considered to be less risky than the other short-term trading strategies, as these traders have more time to endure the short-term price fluctuations.6
Places Where Traders Perform Their Duties
Traders tend to work in a variety of places. Those traders who work for themselves may have a home office or may rent one. If that isn’t the case, traders will have roles in investment banks, brokerage firms, proprietary trading firms, asset management firms, hedge funds, or exchanges. Traders may work in the physical office or remotely, depending on the nature of the trading activity and the firm’s policies.
Trader Operations: Institution vs. Own Account
Many large financial institutions have trading rooms where traders are employees who buy and sell a wide range of products on behalf of the company. Each trader is given a limit as to how large of a position they can take, the position’s maximum maturity, and how much of a mark-to-market loss they can have before a position must be closed out. The company has the underlying risk and keeps most of the profit; the trader receives a salary and bonuses.
On the other hand. most people who trade on their own account work from home or in a small office, and they often use a discount broker and electronic trading platforms. Their limits are dependent on their own cash and credit, but they will often keep all profits.
Discount Brokers: An Important Resource for Traders
Discount brokerage firms charge significantly lower commissions per transaction but provide little or no financial advice. Individuals can’t trade directly on a stock or commodity exchange on their own account, so using a discount broker is a cost-effective way to gain access to the markets.
Many discount brokers offer margin accounts, which let traders borrow money from the broker to buy assets. This increases the size of the positions they can take but also increases the potential loss.7
Foreign exchange trading platforms match currency buyers and sellers in the spot, forward, and options markets. They sharply increase the amount of price information available to individual traders, thus narrowing price spreads and reducing commissions.
The Type of Information That Traders Use
Traders use a variety of techniques to source information. This is essential to make informed decisions and be profitable in their activities. The types of information that traders access include fundamental, technical, or market timing, noise, and sentiment. With this information, traders can even develop a contrarian view or find arbitrage opportunities.
Fundamental Information
Fundamental information, or fundamentals, refers to data that provide insights into the underlying intrinsic value of the financial asset, such as a stock, bond, future, currency, or commodity.
Fundamentals are generally gleaned from economic, industry-specific, and financial data and include economic data, industry trends, company news and events, and financial statements.
Technical and Market-Timing Information
When using technical and market-timing information, traders analyze past and current market data to spot patterns and trends. This is to anticipate future price movements in assets such as stocks, bonds, futures, currencies, or commodities.
Traders use technical analysis and other market-timing information to identify buying and selling opportunities. They use charting techniques and momentum indicators such as moving averages and oscillators to accomplish this. Examples of market-timing information include economic and financial releases, as well as market sentiment indicators.
Noise Trading
Noise trading involves making decisions on factors that seem to be helpful but would usually generate profits equivalent to a random choice. Some of these factors can include rumors, gossip, or emotions. Noise can create market imbalances that rational traders can profit from. Also, noise traders are often associated with retail or inexperienced investors who lack the necessary tools to profit from trading.
Sentiment
Sentiment refers to the overall view of financial market participants. This can be bullish, neutral, or bearish. These views can be toward the financial markets or various assets such as stocks, currencies, or commodities. Market sentiment can be attributed to factors such as economic and financial data, geopolitical events, or company news.
Sentiment indicators are based on data comprising trading volume, price movements, and news coverage of financial instruments or markets. Sentiment is also developed through the quantification of surveys or polls. The data helps to gauge the level of optimism or pessimism in the financial markets.
Contrarian Trading
Contrarian trading involves analyzing market conditions and taking an opposing side of the prevailing consensus view of the financial markets. This is based on the premise that market participants often overreact to events, leading to significant price movements in financial markets.
Contrarian traders identify overbought or oversold conditions in conjunction with trend reversals. High conviction in the trades are required, as the contrarian view by its very definition is often unpopular.
Successful contrarian traders employ a rigorous analytical process to identify potential opportunities and carefully manage risks to avoid significant losses.8
Arbitrage
Arbitrage refers to exploiting price discrepancies between two or more instruments or markets. The assumption calls for taking advantage of mispricing in different markets, buying an asset in one market at a lower price and selling the same asset in another market at a higher price, producing a profit.
These opportunities can occur in stocks, bonds, currencies, and commodities over different exchanges or geographical regions. Arbitrage occurs because of market inefficiencies or temporary imbalances in supply and demand.9
Becoming a Trader
Earning a role as a trader in the financial markets can involve a significant amount of preparation, including education, training, and licensing. Most entry-level trading jobs require at least a bachelor's degree, with employers often seeking graduates who have majored in business, economics, and accounting. A master's in business administration (MBA) may be an important qualification for higher-level positions at trading firms.10
Companies that hire traders generally offer employee training programs that focus on the business and the particular types of assets sold by the firm. Brokers and investment bankers working with registered firms must obtain a license from the Financial Industry Regulatory Authority (FINRA), which involves passing a series of examinations to verify their knowledge of the financial markets. Additional professional certifications such as the Chartered Financial Analyst (CFA) designation and the Chartered Market Technician (CMT) designation may expand a trader's opportunities and chances for career advancement.10
Salary and Employment Outlook
Many people may be interested in working as a trader because of the possibility of earning a substantial paycheck. For traders working on their own behalf, generating income will depend on implementing a successful trading strategy and effectively managing risk. Meanwhile, traders working for financial firms may earn a base salary with the potential for a substantial bonus based on their performance.11
According to the U.S. Bureau of Labor Statistics (BLS), as of May 2021, the median annual wage came to $62,910 for securities, commodities, and financial services sales agents—a broader category that includes many traders. Those working specifically in securities, commodity contracts, and other financial investments and related activities earn a median annual wage of $98,030.11
If that level of income seems attractive, there is good news about the employment outlook for the industry, as predictions call for a healthy availability of jobs over the coming years. The BLS estimates that employment for securities, commodities, and financial services sales agents will grow 10% from 2021 to 2031, exceeding the average for all occupations. While competition for these positions may be intense given the necessary skills involved, the BLS estimates that 46,600 job openings per year in this area over the decade.12
Why is trading important in finance?
There are several reasons why trading is important in finance. Trading in financial instruments produces price discovery, generates liquidity, brings out capital flows, and aids in price efficiency. Through trading, market participants converge toward the fair value of financial assets. Also, with trading, liquidity is generated, enabling the quick transfer of stocks, bonds, futures, commodities, and currencies.
What is the difference between trading and investing?
There are two major approaches to the financial markets: trading and investing. While they share some similarities, trading and investing differ in terms of time horizon, risk tolerance, and investment style, as well as approach. Trading is short-term in nature, while investing is long-term in nature. With investing, a more passive approach is taken. Investors will adjust their portfolios occasionally to reflect their long-term goals. Trading is much more active, with the frequent buying and selling of securities.
What are the asset types for traders?
Stocks, bonds, currencies or foreign exchange, options, futures, commodities, cryptocurrencies, and exchange-traded funds (ETFs) are the most common type of assets that are traded. The asset class is dependent on the traders’ preference, expertise, and the market in which they operate. Also, traders can choose to specialize in one asset class or more, depending on their goals and skills.
What are the benefits of being a trader?
There are several potential benefits of being a trader. Traders have a high propensity to generate earnings. Traders tend to work in a fast-paced and exciting environment. This would appeal to people who like being in a highly dynamic space. Traders can have the flexibility to work remotely and work nonstandard hours. Traders gain significant exposure to the financial markets, as they have to actively and closely monitor them along with the factors that drive the respective markets.
What are the limitations of being a trader?
In any role, there are advantages and disadvantages. For traders, there are a handful of limitations. Trading can be a high-stress and competitive profession, which isn’t suitable for everyone. There is also a risk of financial loss. Moreover, traders work long hours. When markets are in a downturn, there is a high potential for traders to lose their jobs. To be a successful trader, people often need to attain specialized education, training, and experience, which can be time-consuming and expensive.
The Bottom Line
Trading is a highly skilled profession that provides price discovery and liquidity in a multitude of financial markets, including stocks, bonds, currencies, commodities, or derivatives. Traders can either be entrepreneurs or work for investment banks, hedge funds, or proprietary trading firms. Also, they use various strategies and tools to look for opportunities as well as to exploit market inefficiencies or mispricing.
To gain an edge, traders analyze market data and news, as well as economic and financial indicators. Also, traders may use technical analysis, quantitative models, or algorithms to execute their orders. Traders need to have strong analytical, quantitative, and problem-solving skills. Beyond that, they need to be able to manage risks and work under pressure. Successful traders can make huge sums of money, but trading is also associated with sizable risk and potential losses.
