As day traders, it is important to remember that when making trades intraday it is highly likely that you will transact against another day trader or a designated market maker - and their algorithms. This can result in frustration for inexperienced traders because they fail to realize that the other party has a contrary interest and motive for the transaction. By making a transaction there is now a possibility that the counterparty may take steps to make you lose on your trade so that they may gain. While the market is by no means a one-on-one battle, seeing what kinds of players a trader may encounter on a particular trade and in a particular environment can help them better understand how they can improve their own trading.

The Trading Environments
Traders will often trade in certain market environments. While the environment can change due to events that may occur, when a particular environment is in play it is highly likely you will encounter certain types of traders. While there are other trading environments, the following are the most common trader types who will trade within them. After knowing what kind of environment we are trading in, we can then understand with whom we are likely transacting. Also, when the environment shifts we can be aware of what types of traders - or associated algorithms - are likely to enter that market. (If you can multi-task and enjoy a good challenge, this lucrative career could be a perfect fit Hotshots Needed For Commodity Trading Advisor Positions.)

High Volume, Low Volatility
These markets are characterized by relatively small intraday movements, large bids and offers at each price level and relatively high volume.

In this type of environment, there are several usual participants:

  • Designated Market Makers (DMM)
    These participants' main function is to provide liquidity to the market, yet they also attempt to the profit from the market. They have massive market clout, and will often be a substantial portion of the visible bids and offers displayed on the books. Profits are made by providing liquidity and collecting ECN rebates, as well moving the market for capital gains when circumstances dictate a profit may be capturable.
  • Liquidity Traders
    These are non-market makers who generally have very low fees and capture daily profits by adding liquidity and capturing the ECN credits. As with market makers they may also make capital gains by being filled on the bid (offer) and then posting orders on the offer (bid) at the inside price or outside the current market price. These traders may still have market clout, but less so than market makers.
  • Technical Traders
    In almost any market, there will be traders who trade based on chart levels, whether from market indicators, support and resistance, trendlines or chart patterns. These traders watch for certain conditions to arise before stepping into a position; in this way, it is likely they can more accurately define the risks and rewards of a particular trade. At commonly known technical levels, the liquidity traders and DMM may become technical traders. Although not always in the way expected - DMM may falsely trigger technical levels knowing large groups of traders will be affected, thus churning large amounts of shares. (Learn more in our Technical Analysis Tutorial.)

    High Volume, High Volatility
    These markets are characterized by relatively large intraday movements, small bids and offers at each price level and relatively high volume.

    In this type of environment there are several usual participants:

    • DMM (see above)
      These are present, but will be less involved at each price level. They may still do large volume, but are less obvious on the book compared to the low volatility stocks.
    • Momentum Traders
      There are different types of momentum traders. Some will stay with a momentum stock for multiple days (even though they only trade it intraday) while others will screen for "stocks on the move," constantly attempting to capture quick sharp movements in stocks during news events, volume or price spikes. These traders typically exit when the movement is showing signs of slowing. (This type of strategy demands controlled decision making, requiring a continual refinement of entry and exit techniques, read Momentum Trading with Discipline.)
    • Arbitragers
      Using multiple assets, markets and statistical tools, these traders attempt to exploit inefficiencies in the market or across markets. These traders may be small or large, although certain types of arbitrage trading will require large amounts of buying power to fully capitalize on inefficiencies. Other types of "arbitrage" may be accessible to smaller traders such as when dealing with highly correlated instruments and short-term deviations from the correlation threshold.
    • Technical Traders
      Just as with the high volume, low volatility stocks, technical traders can be found in almost any market.

    Low Volume and Low/High Volatility
    The main characterization of these stocks is low volume. Even though there may be few transactions those transactions may take place over a large price area, or a small price area.

    • DMM
      These traders may be visible on low-volume and low-volatility stocks attempting to collect ECN rebates on transactions that do occur. On low-volume but high-volatility stocks, the DMM may be less visible on the books (small orders).
    • Liquidity Traders
      They may also be in these environments, but while they provide liquidity on the ECN books, they will also attempt to make a momentary gain on the shares to compensate for the low liquidity risk. (Discover how two groups work together to keep the market functioning properly. See Traders And Investors' Roles In The Marketplace.)
    • Other Day Traders
      They are unlikely to be in this environment, unless there is a large volume and price spike to capture their attention or a statistical anomaly is significant enough to offset potential low liquidity risks.

    Know Your Counterparty
    Having an idea of your potential counterparty in a given environment can provide insights into how the market is likely to act based on your presence/orders/transactions and other similar style traders. A DMM, for example, is unlikely to continually add liquidity as the price moves against them indefinitely. At some point, they attempt to re-capture lost capital gains. A market maker cannot last long losing money.

    In high-momentum environments, momentum is likely to continue beyond what many expect because of the nature of trader that is attracted. Momentum brings in more momentum traders, creating a further price catalyst. Price movement catalysts are also often technical levels.

    While not everyone is a technical trader, being aware of major market signals that many other traders watch (such as a 50-day or 200-day moving average, pivot points or major support/resistance) can provide important information. As mentioned before, certain types of traders will exploit the fact that many traders are watching these levels. Day traders must be aware of the potential impact the technical level may have, as well as realize that the level may be exploited to churn shares before the technical level creates the actual price movement expected from such a technical level. (Learn one of the most common methods of finding support and resistance levels Using Pivot Points for Predictions.)

    Also, when trading securities that have strong positive or negative correlations with other securities or asset classes, it is important to be aware of those correlations as well as when those correlations are breaking down, and possibly attracting the attention of arbitragers.

    When we can begin to see our counterparty's intentions, we can align our strategy to theirs or attempt to exploit the common tactics of the counterparty.

    Not all stocks are the same because the traders are not the same. Understanding what potential counterparties are in a stock can help provide valuable insights. High-volume, low-volatility stocks are dominated by market makers and liquidity providers as well as some technical traders. High-volume, high-volatility names will have market makers, technical traders, momentum traders and may attract arbitragers.

    Low volume stocks are likely to see market makers and liquidity providers, although they trade for capital gains as well due to the spreads and low liquidity risk. Being aware of the styles of these traders can aid day traders in understanding their counterparty by creating an accommodating strategy or strategies designed to exploit common actions of the counterparty. (From picking the right type of stock to setting stop-losses, learn how to trade wisely, check out Trading Through A Market Maker Vs. An ECN and Day Trading Strategies For Beginners.)