Introduction To Types Of Trading

Introduction To Types Of Trading:
By Jason Van Bergen

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 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 conflicting 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 later when you are establishing your style.

Some of your first decisions 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 to 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.

Here are the major styles of equity trading:

Scalping - The scalper is an individual who makes dozens or hundreds of trades per day, trying to "scalp" a small profit from each trade by exploiting the bid-ask spread.

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.

Technical Trading - 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.

Fundamental Trading - Fundamentalists trade companies based on fundamental analysis, which examines things like corporate events such as actual or anticipated earnings reports, stock splits, reorganizations or acquisitions.

Swing Trading - 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 devote the balance of this article to explaining scalping, a trading technique which which the trader scalps small profits by exploiting the spread of a slow-moving stock. Here are articles that explore the other types of trading: momentum trading, technical trading and fundamental trading and swing trading.


The Scalper
The scalper generates trading profits from stocks that are not moving, make tiny (or teenie) profits from each trade by buying a stock on the bid and then turning around and selling 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.

The scalper's role is exactly the same as that of the market maker (also known as the specialist), a dealer who, 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 trades 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 advantages: 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 and one sixteenth, 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 and selling at $10.01 generates only $10 in profits, most likely not even enough to cover trading commissions.

This is not to say that scalpers' opportunity for profits have been lost. 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 he or she can derive profits is the trader's utmost goal. Once that niche is found, the scalper can refine his or her technique, successfully trading for pennies just as he or she was trading for teenies.

Again, here are other articles on the other types of trading: momentum trading, technical trading and fundamental/swing trading.