Market makers are responsible for continuity and liquidity in the market. It is usually an individual for a firm that quotes both a buy and a sell price for stocks that they currently have in their inventory. They hope to make a profit on the spread, (the difference between the bid and offer).
Market makers as a whole are responsible for sustaining a fair an orderly market but work independently from one another. They have access to basically the same information as the most day traders with a key exception, they already have order flow and may have an better idea of which way the market in that stock is going.
Market makers compete for business ( order flow) and thereby earn more spreads creating more liquidity making it easier for them to trade. In essence Market makers are trying provide good order fills for their customers while making money for themselves via the spread.
I always try to tell people what they need to do in order to have a legitimate shot at become a successful trader, but it dawned on me that I rarely point out the equally important factors that cause as many as 90% of all new traders to fail. By fail we mean lose money since that is what this game is really all about, success equates to making money while failure is associated with losing money. Of course there are different degrees of success and failure, and then what do we consider breaking even? But, for now lets just concentrate on common flaws or mistakes that are the recipe for a failed career as a trader.
Now, although we keep score in trading by keeping track of your P&L, this does not necessarily mean the P&L at the end of the day. I have seen many traders have an incredible day or two only to end up at the end of the week or month in the red. Being a successful trader is achieved over a longer period of time as very few if any traders win everyday. At the end of the year are you going to have gains or losses. It’s really as simple as two colors, red or black. Here some reasons for constantly ending up in the red.
Many of today’s new trader’s hear stories of the ‘old timer’s’ in the late 90’s who watched their screens turn green for pretty much anything they bought, and to some extent it was the heyday of day trading. Well, get over it, those days are long gone and you now need to have a process for becoming a successful trader. Not having a sound approach or series of techniques will cause you to rely on guesswork and new day traders have not yet developed anything that can be called instincts, and sometimes for a day or two you may feel like you have an instinct for the way a stock will move, but this will undoubtedly work against you over time. The way in which you identify opportunities and trends in the market will be the main ingredient in determining your future as a day trader. Consistency in picking up those buy and sell signals that fall within your approach to trading is the all important factor.
Consistency is based on sound fundamentals and discipline. I have seen so many traders try to reinvent their approach on the fly and this very seldom works, especially with newer traders. If you are using 3-minute charts or 5-minute charts or any charts for that matter you must use the same approach to identifying entrance and exit points. Of course there will always be certain circumstances that dictate you make changes to your approach, but these usually take the form of a major event or news item. But if you have the obedience to stick with your methodology your chances of success will be substantially higher.
Just because you had enough money to open a day trading account does not mean you as of yet have the ability to turn that money into profits. In fact most new traders are usually down before they are profitable. Don’t think that you are going to take the day trading world by storm, just build a solid foundation and learn to trade before declaring yourself the next great trader. Learn your craft and do not be afraid to ask questions of those who are getting the results you want. Most of those guys were at one time in your shoes and are usually happy to help. Be realistic and hone your craft in order to be in it for the long term. Too many new traders swing for the fences when a career is built on lots of singles and doubles.
Another reason for new trader failure is they too often try to force trades that clearly are not there. “Taking a shot” might be okay for seasoned trader who has already banked substantial profits and finds its sometimes fun to take that shot. But that isn’t you, at least not yet, so you must wait for that trade that fits into your basic approach and don’t force trades just trade. Sometimes the best trade is not to make one. The markets have thousands of stocks to trade and eventually a few of them will catch your eye.
It also may be a good idea to visit the articles on this blog about risk and money management as everyone has losing trades and losing days but the key to staying in the game is minimize your losses and maximize your gains in order to stay in the game long enough to really understand your craft. Learning why people fail is one of the most important factors in learning how succeed!
An essential factor in using volume to indicate a potential price surge is watching the stock price in relation to the volume. Stock moving up after forming a solid base of increasing volume and price is a sign investors and traders are jumping in to the game, while price gains in relatively weak volume may indicate that the big boys are playing and price gains may be short lived.
Keeping an eye on the relative strength of the stock compared to market average is also necessary in confirmation of a volume break out. The stock should be approaching new highs and outperforming the proper index. Determine if the stock is leading the way of lagging behind the broader market and be prepared to run like hell if it has weak volume when everything else in its sector is gaining significantly.
Increased volume is a good indicator of whether a stock is gaining steam and poised to break out to new highs, your ability to read the signals in a timely fashion is a key component to your survival as a trader.
The need for speed is a phrase that comes up frequently among those swing and day traders who use the news wires to identify potential trades. The news wires are constantly putting forth new stories containing information that can affect the value of a stock. How the trader interprets this information will determine the position he decides to take, if any.
There are different ways to play the news, especially if news is expected, such as
earnings. Earnings are generally released quarterly and can cause some increased volatility in a stock in the moments immediately following the earnings news. If the earnings are released after market hours there can be significant price gaps either to the up or downside depending on what the street was expecting. When news such as earnings are released the trader has known when it will be coming for sometime and can do his or her due diligence to determine what they may do when the exact information is known.
This is important because quite often a stock may have positive earnings or are ahead of last years numbers for that period, but the street was expecting better; this can cause negative sentiment and send that stock into a tailspin.
You hear the phrases “The Street”, “Sentiment” or “Tone of the Market” and to make a long drawn out explanation short, it just means what those involved in the daily trading of stocks, bonds and derivatives are feeling that day about the overall market or sectors of the markets. Negative sentiment usually signifies “the street” is bearish on something and positive sentiment signifies Bullish. Earnings and certain reports are scheduled for release but many news items that affect the direction of the market or a particular issue are unplanned and traders will have to identify if there are factors that will drive value up or down. Getting in early when playing the news is vital, as many newer traders tend to take positions when seasoned traders are exiting.
To play the news, whether scheduled or unexpected a trader needs to be reactive, he or she needs to see the news and then process that information quickly to determine whether the anticipated move will be up or down. Scheduled news such as earnings or research releases can move the value quickly but are usually more indicative of longer-term thinking.
Investors might use news to confirm their own feelings or research about a stock or sector and attempt to take advantage of a longer time horizon move, perhaps months or longer whereas day traders are looking for that initial reaction and grab profit from possibly entering and exiting several times as the moves in an issue continually attempt to find equilibrium.
Many of you who have read this blog, or have sat through some of my seminars way back when day traders were called SOES bandits, (named after the old Small Order Execution System) have heard me say ‘Trading is not Investing’ hundreds of times. It’s still true today. The mindset of a trader is considerably different from that of an investor and although the ultimate goal for both philosophies is to make money, the approaches to that end are very different.
The capital that an investor uses to enhance his net worth is going to be tied up for significant periods of time. He seeks to increase his wealth by investing it in Stocks, Bonds, Real Estate, etc that he feels are fundamentally sound. If he is looking at stocks he may be looking at a balance sheet or growth potential, perhaps even the management of the company. The investor is looking at the big picture and is willing to wait a certain period of time for his investment to grow.
For the average guy on the street, he may want to have some investments working for him but lacks the knowledge or time to accumulate enough information to risk his hard earned capital. The average investor may understand many generalities about certain sectors of the market and have an opinion that he or she would like to act upon, for these types of investors mutual funds have provided a way to do this.
Traders live and die with market volatility. The time horizons for active traders and day traders can be a short as seconds or perhaps up to a few days in the case of swing traders who may hold a stock for a few days in order to take advantage of “swings” in the market. Active traders are looking for short-term price changes. They do not care about the fundamentals or dividends, just to catch a move and profit from it.
The active trader doesn’t really care whether the market is going up or down, only that it is moving. A day trader may concentrate on watching the news wires to pick up some event or news release that will cause a stock to move. Technical analysis, the use of charts is used instead of Fundamental analysis and charts used can be in increments of minutes instead of years.
During my time as a day trader, I rarely would hold positions overnight as it was risky not knowing what Domestic or International event would cause a major move against my positions. Although on occasion I would hold a stock I already had booked some profit in overnight, there was something calming about being a day trader, with no positions at the end of the day, it made for a more restful sleep.