Understanding the Players in the Market

April 22, 2010
Donald Berger talks about the three types of players in the stock market that self-directed investors need to understand.

by Donald R. Berger, DDS, FAAP

A self-directed investor needs to understand the players in the market. These are the specialists or floor traders, the commercial or institutional traders, and the speculators.

Floor or specialist (market maker) traders
Foor traders are responsive traders. They buy weakness and sell strength. They love consolidating and efficient markets. They are contra trend traders. In a trending market, they spends a lot of time against the trend. The specialists are making the market. Their job is to make a market when there is an imbalance of orders. Therefore, they sell strength when there is an imbalance of buy orders and buy weakness when there is an imbalance of sell orders. Their job is to find a high price that stops buying and a low price that stops selling. They have the house edge and depend on that edge to make their profits. They generate a small commission cost. Theirs is a high volume and small mark-up business. The market opening belongs to the specialists. This is their most active time of the day ,and most volume occurs at this time. They can balance the market in 60 to 90 minutes of trading. Seventy percent of the time the high or low for the day is made within the first 60 to 90 minutes of trading.

Commercial or institutional traders
These traders are responsive traders 90% of the time. They are attracted by extreme prices. Extreme or long-term prices are attractive because commercial or institutional traders have an economic use for the product or stock. The close of the market belongs to the commercial trader. They initiate trading (longs and shorts) when forced by overwhelming volume or a large fundamental change in the market. The commercials have a real economic use and interest in the product or stock. The commercials also have inside knowledge about the condition of the company or product before it is discovered by the market or the media. These traders are either producers of the product or stock or they are distributors of the product or stock. If they are tproducers of the stock or product, they are sellers. If they are the distributor of the stock or product, they are buyers. In commodities, the producers or short hedgers would be farmers, mining companies, etc. The distributors or long hedgers would be grain merchants, wholesalers, etc. The producers of a stock would be the treasurers or sellers of that stock. The distributors of the stock would be brokerage houses or mutual funds. Since the commercials distribute the product or stock and know where to distribute it, they can be sell strength and buy weakness traders. They are just looking to capture a percentage of the spread and book a small profit while they deliver or take delivery of the stock or commodity. They have a very large capital base, special exchange privileges, special leverage privileges, and extremely deep financing structures. They have a low commission cost because of their volume and order flow.

Speculators have no economic use or interest in the stock or product as with the commercial trader. Highs or lows attract the speculators. They are initiating trades most of the time. If they are responsive traders, they must manage risk very carefully and/or be well-capitalized and hedged. The speculators have high commission costs compared to specialists or commercial and institutional traders. They have limited capital, no special privileges, and large slippage costs. They are low volume, high mark-up traders, because they have no edge for the product or stock. They also has no edge in special exchange privileges. If they are to succeed over a large sample size, speculators must buy strength and sell weakness. If they do trade contra trend, they must be prepared to be wrong and admit their fallibility. The speculators best performances are when the market is inefficient.

With time and devotion to learning and understanding the markets, anyone can become a self-directed Investor.

For more information, Dr. Donald R. Berger can be reached by e-mail at [email protected] or by phone at (215) 896-7448. Visit his Web site at www.dberger.org.