Understanding the different types of market participants

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John Forman - The Essentials of Trading author

“…market behavior is the sum total of the actions of all of its individual participants and disciplines and timeframes.”

That’s a quote from Markets in Profile. I mention it here because sometimes new traders forget that fact. I’ve responded to the question of why anyone would buy in to a market that is clearly moving lower, or some variation thereof, numerous times. If we all traded in the same timeframe and for the same reasons, then the question would be valid. More than likely, it would also make for a very difficult market to effectively trade.

The fact of the matter, though, is that traders operate across a huge range of trading timeframes. There are the scalpers who work on the extreme short end of the time scale, holding trades for seconds in some cases. At the complete opposite end of that spectrum is the likes of Warren Buffett, who will buy something with the expectation to hold it for years. Most of us fall somewhere between.

I can understand why new traders sometimes don’t quite see that. There is such a focus on relatively short-term trading that sometimes the longer-term participation can get overlooked. Understanding that there are folks operating on different timeframes helps to clarify why someone would be buying when prices are clearly plunging. What is clearly a short-term downtrend could be a great buying opportunity for a long-term trader.

Here’s another thing to be considered. Not all participants in the markets are speculators after profits. Think about it for a second. Companies issue stock. That’s selling. They sometimes do share buy-backs, and many do market purchases for employee stock plans and whatnot. You wouldn’t call that speculation. Those are just business transactions. There are a great many businesses that make trades in the market to hedge their business exposures, be that interest rate risk, the cost of their raw materials, even the price of their finished products in some cases.

Perhaps the most active of non-speculators is actually the group of market participants referred to as market makers. These are the folks most responsible for providing liquidity by taking the other side of buy and sell orders. They don’t do it to take a position on the direction of price, but to make numerous small profits by earning the spread between where they are able to buy (at the bid) and sell (at the ask/offer).

It really is the confluence of all of these various participants that drives prices. Understanding that can go a long way to helping one see and comprehend the patterns of price behavior.

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Here are some other posts which might interest you:

The value of short-interest
Charting, data and the bid/offer spread
Where do prices come from?
How do you forsee when institutions decide to trade?
The Zero Sum Game