I am continually amazed at the number of different types of speculators that exist in the financial markets.  While many professions encourage specialization, I can’t think of any others that take it to the same degree.  Even medicine, with its 50-100 specializations (depending on how you count) can’t come close.

From the perspective of educating traders, specialization presents a real challenge.  Much of the information on the web, in books, and passed via word of mouth is specific to one trading methodology.  Sadly, what’s true for one specialization may not be true for another and the result is rampant confusion.  There is, of course, a core of information that is common to all speculators – much as there is core anatomic knowledge that all doctors need to know.  But it’s easy for that universal information to get lost in the shuffle.  Combine this with the incredible quantity of trading misinformation out there, and it’s no wonder new traders have a hard time learning their craft.

There is no real solution to this problem from a pedagogical point of view.  The sheer number of specialties arise as a consequence of the complexity of the market and aren’t going to go away – in fact as new products and technologies are created the field seems to become more fragmented.  I think the best a novice speculator can hope to do is recognize the problem and classify incoming information in terms of what kind of speculation it applies to.  Of course, in order to do that you need to know what the choices are.  To that end I tried to lay out a map of all the types of speculators, but quickly found it to be an impossible task.  There were just too many.  I think a better way to understand the situation is to describe a number of axis on which speculators and their strategies can be classified:

• Technical vs. fundamental vs. news
  • Technical traders base their trading decisions on numeric information about the price and trading volume of one or more securities over time.  This can include addition information like order book/depth of market (DOM) and tick/time and sales tape information about individual trade executions.  Most technical traders use various types of charting and mathematical or visual indicators to make additional sense of this information.  Quantitative (“quant”) traders are a subset of technical traders who put more emphasis on sophisticated mathematics to analyze data.
  • Fundamentals traders base their trades on economic information, usually betting that over the long run certain known economic relationships will hold.  They frequently pay little information to chart studies or previous price and put more emphasis on determining what the price of a security ought to be based on the totality of information about it.
  • News traders are a variant on fundamentals traders.  They specialize in the effect that news will have on a security’s price either by trying to react very quickly to breaking news, or by trying to predict the news itself and what its impact will be.
• HFT vs. scalping vs. day trading vs. swing trading vs. position trading
  • High frequency traders (aka HFT) specialize in trading on incredibly short time frames – typically shorter than human reaction time.  As such their strategies must be automated via computers, and those computers are frequently co-located near electronic exchanges to minimize latency.  Most HFT strategies center around automatic market making, program trading, and statistical arbitrage.
  • Scalping is trading where decisions are made on a time frame between human reaction time and typically a few minutes.  The goal is typically to capture small price movements or sometimes just the bid/offer gap.  Historically scalping was the province of open outcry pit traders, but now like most other trading activity it has moved to the electronic arena.
  • Day trading is trading on a time frame longer than scalping, but sufficiently short that all positions are closed before the market closes for the day.  The concept arose as a means of avoiding overnight risk – the risk the a leveraged security position would move against you while the market was closed, possibly running through protective stops resulting in large losses and causing margin calls or other liquidity problems.  The goal in day trading is still to capture relatively major movements in price compared to scalping – up to a couple of percent –  without said overnight exposure.
  • Swing trading is somewhat similar to day trading, but the speculator is willing to assume overnight risk.  This risk can be managed via diversification, reducing (or eliminating) leverage, and by using hedges such as buying put options to offset the risk.  As a result positions can be held longer –  swing trading typically implies holding periods between overnight and a few weeks.
  • Position trading is any time frame longer than swing trading – holding positions for months, years, or indefinitely.  It is typically associated with fundamentals (the shorter time frames are mostly the domains of technical and news traders).
• Macro vs. micro
  • Macro (or sometimes “global macro”) speculators are interested in the behaviors of the economies of large nations, regions, and the world as a whole and trade to profit from those behaviors.
  • Micro speculators are interested in one security or a small group of related securities and develop strategies that try to isolate their chosen instruments from the rest of the world.
• Flat price vs. volatility vs. spread
  • When you trade flat price you’re trading just the price of a security – long or short.  All trading examples on this blog up to this point have been flat price trades.
  • Volatility traders make bets on how much the price of a security will move without betting on which direction it will move.  This is done using options, which are a type of derivative contract where the value changes depending on the amount of future price movement expected.  When combined with the underlying security, this can create positions that respond to volatility while being somewhat price neutral.  The mathematics behind options and price neutral positions (sometimes referred to as “delta hedged”) are too complicated to describe with any clarity here.
  • Spread positions consist of being long one security and short another, correlated, security.  The trader profits if the spread between the prices moves in the anticipated direction.  The purpose of spread positions is generally to hedge out unwanted aspects of a trade and keep desired ones.  For example, if you think XYZ corp will do better than the US economy as a whole, but you have no opinion on how the economy will do, you might choose to go long XYZ stock and short the S&P500.  This would result in keeping the desired exposure to XYZ’s performance but filtering out the undesired exposure to the broader economy that comes with it.
• Trending vs. mean reversion
  • Trend trades are bets that price (or volatility, or a spread) will continue to move in the direction it has been moving.
  • Mean reversion trades are bets that price will move back close to previous average values after moving away from it.  This is the opposite of trend trading.  Most market marking in inherently mean reversion oriented.
• Discretionary vs. systematic
  • Discretionary speculators do not have a fixed system for determining what speculations they enter into.  They usually have some rules or guidelines and economic principles, but ultimately the decision rests on personal judgement.  The discretionary approach can be useful for responding to one of a kind macro events, since there are few or no historical precedents for the purpose of developing a system.
  • Systematic speculators develop and test systems with well defined rules that determine what trades they take.  These systems may be discovered by any number of means, but are usually verified by means of statistical analysis.  They try to remove their on-the-spot judgement from the equation.
• Manual vs. automated (note: this distinction only applies to systematic traders)
  • Manual systems traders implement their systems via entering the orders themselves by hand or with limited computer assistance (perhaps a chart trader).
  • Automated system traders program a computer to make the decisions for (and possibly actually enter the the trades for) their systems.  This largely eliminates the human element which can greatly reduce mistakes.  But it also can pose a programming challenge since many strategies which are easy for a human to implement are relatively difficult for a computer to implement.
• Liquidity supplying vs. liquidity consuming
  • Liquidity supplying (aka market making) speculators add non-marketable limit orders to the order book.  Thus they sacrifice total control of their position (which limit orders do not offer) in return for better prices on their trades when they do get their orders filled.
  • Liquidity consuming speculators trade via market orders or marketable limit orders which give them total control over their position, but at the cost of getting worse prices.
• Institutional vs. retail
  • Institutional traders trade for a bank desk, prop desk, hedge fund, or other institutional entity.  Capital, training, exchange memberships, data services, back office & clearing services, IT infrastructure etc. are usually provided by their employer.  Most institutional traders have securities licenses – series 7 and now series 56 are common in the US.   The means of paying institutional traders varies but typically consists of a salary plus performance bonus, with poor performing traders being fired or moved to less risky positions.  In some cases the trader may have an equity stake in the institution and thus profit directly from their trading results as well.
  • Retail traders trade through a retail broker, and typically trade their own capital thus directly experiencing all profits and losses. This is frequently Joe Sixpack trading at home through his online discount broker (ETrade etc.).  But sophisticated retail traders can potentially have brokerage, data, clearing and exchange membership situations indistinguishable from a small institution.
• Exchange traded vs. over the counter (OTC)
  • Exchange traded products are traded on an electronic exchange.  Traders of these products are typically just one of many trading the product world wide and must compete with others for the best prices.
  • OTC products are custom created for interested customers and may have unique terms and only one available counterparty.  Essentially all OTC products are derivatives and all OTC traders are liquidity supplying from the short side since the product wouldn’t exist unless they created it.  All OTC traders are institutional.

As you can see the speculating landscape is diverse to say the least.  Nearly any combination of these factors produces a legitimate type of speculation, although a few don’t make much sense (a HFT fundamentals trader would be a very weird animal for example).  Of the niches that make sense, most of them are populated by an entire group of traders who make a living there and have their own subculture and even terminology.  No wonder discussions about trading so often seem like talking past each other instead of to each other – the amount of common ground can be surprisingly small.

When you combine all these choices with the broad range of financial products available, you can see just how many types of speculators there are.  So next time you run across some trading advice in a book or on the internet, try to figure out where in this landscape the advice giver comes from.  If their approach is very different than yours, expect that the information will be of limited use or at least require a lot of translation.  And if you’re new to trading and haven’t decided where to specialize look over this list and see which approaches seem to appeal to you and start your investigations there.

For the record, my trading background is primarily:

• technical
• scalping & day trading
• micro
• flat price
• either trending or mean reversion
• systematic
• either manual or automatic with a preference for automatic
• liquidity supplying
• retail brokers & exchange traded products