TIME-FRAMES FOR TRADING

There are three broad timeframes in which traders tend to operate. The boundaries between these are by no means fixed, and some of the strategies we will cover can be used in many timeframes.

• The shortest time frame is ‘intra-day’, also known as ‘day-trading’ because positions are both opened and closed within a single day and are never held overnight. Day-traders will hold a position for anything from a few seconds in the case of a scalper to the whole session in the case of someone who has bought into a breakout at the open and has no reason to exit before the close. Because they always go home ‘flat’, the main advantage that day-traders often remark upon is how well they are able to sleep at night!

• Short to medium term trading is usually referred to as ‘swing-trading’ because it usually aims to take advantage of moves in the market as it swings from highs to lows. Many other techniques are also employed by swing traders however, such as breakout systems similar to those used by day-traders but executed from longer timeframe charts and held over several days. Swing traders believe that the large, profitable movements in a market only take place over longer timeframes, and often even doubt the ability of the day-trader to make money. It is not uncommon to hear a swing trader claim that they cannot sleep easy at night unless they have a position open!

• Finally, a very considerable proportion of market participants (including most public speculators and most financial institutions such as hedge funds) prefer to buy and hold a security over a long period of time. This is especially true of stocks and shares, which is obviously also relevant to the value of the indices, and government bonds. To a lesser extent it is also true of commodities, usually with the intention of hedging against exposure to risk in a company’s commercial operations. Trading in these timeframes is also known as ‘position trading’.

TermsOfTrades

In the illustration above the thicker lines represent trades taken by a swing-trader, while the thinner lines represent those taken by a day-trader. Can you see how the two fit together? The swing trader holds a position for a sustained up or down leg in the market, ignoring the fluctuations and retracements that occur throughout the course of this, while the day-trader takes advantage of numerous smaller moves within this. The position-trader, meanwhile, is long for the entire duration shown on the image, and will perhaps remain so for another two years. The swing-trader’s entries are to the position trader’s what the day-trader’s are to the swing trader’s.

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A MARKETPLACE WALK-THROUGH

Suppose that the market is in a steep up-trend, and I decide that I want to be a part of that trend, so enter the market with a buy order. In order for a transaction to take place, there must be someone who is willing to sell to me. But why on earth would anyone want to sell to me when the market is in such a steep up-trend?

There are various reasons for this:

• Someone else may have bought into the trend much earlier. They now want to exit their position and take their profits. Because they bought to enter the position, they must sell to exit it.
• Someone else has a different assessment of future price direction to mine and therefore they want to do the opposite to me, so they enter the market with a sell order. We cannot both be correct, obviously, and for only one of us will the trade prove profitable.
• Someone else wishes to establish a position because they have a different agenda within the market to me. While I expect price to rise over the next few hours, they may be entering the market with a sell order because they expect price to fall over the next few weeks, months, or even years. Or they may have no expectations of the market whatsoever, and may just be looking to hedge other activities, whichever way price moves. More of this in a moment.

Many different people, organisations, banks, and funds all speculate within the marketplace for very different reasons. Let’s try and build up a picture of how this works with different types of traders, and how their different expectations interact.

AMAZING AIRLINES are worried that the price of jet fuel (which is derived from crude oil) is set to rise. This will make their operating costs more expensive, and they will either have to operate at a lower profit, or maintain their profit margin and pass on these costs to their customers. If they do the latter, they may lose customers, and so their profits may decrease anyhow. Neither of these options is attractive, so they decide instead to hedge their position by buying contracts in crude oil. This protects them whatever the outcome – if fuel prices do rise, then their operating costs will increase, but the value of their investment in crude oil will increase by an equal amount. If fuel costs drop then the value of their investment in oil will decrease, but this will be offset by the increased profits because their operating costs will be less.

AMAZING AIRLINES contact their broker FANTASTIC FINANCE, who has lots of staff on the floor of the Chicago Mercantile Exchange where contracts in crude oil can be bought and sold. One of the phone clerks sitting at a desk at the edge of the floor takes down the order, and passes it to a runner, who takes it to their broker in the pits. If it is busy, the phone clerk may communicate directly with the broker through elaborate hand signals or shouting.

FANTASTIC FINANCE’S broker executes the trade by buying the contracts from SCALPER SAM. SCALPER SAM is a Market Maker. Having bought the contracts at a lower OFFER price, he now aims to sell them where the BID price is higher, thereby making his profits from the spread. He will hope to scalp these small profits hundreds of times throughout the day.

SCALPER SAM bought these contracts just a few moments before at a lower OFFER price from SPECULATOR SMITH. A technical trader, SPECULATOR SMITH has been studying his price charts and watching the news, and is convinced that prices in Crude Oil cannot get much higher and are set to plummet sometime soon. So he decides to sell contracts in an attempt benefit from his predicted price decline. Ultimately, SPECULATOR SMITH has assumed the original price risk of AMAZING AIRLINES.

From this example we can begin to identify some of the common market players:

• The Hedger – Is usually a company whose business is exposed to the real world risks of price changes in a particular commodity, and who aims to limit this risk by ‘betting both ways’ on future price movement.

• The Broker – Is responsible for carrying out the actual buying and selling on behalf of a client, aiming to get the best price available at that time. Because they act on a fixed commission, brokers are completely immune to price changes. Because they operate on behalf of many clients they improve the efficiency of the marketplace.

• The Market Maker – trades risk liquidity and aims to profit from the SPREAD. A side effect of his activity is to ease the process of buying and selling and maintain liquidity in the market, acting as a shortcut for those who want to jump straight to the front of the BID/ASK queue and pay his prices. Scalpers operate on a price differential between buyers and sellers within the same market place at different times; those who operate on a price differential between different market places at the same time (eg the value of the pound in London versus the value of the pound in Hong Kong) are known as arbitrageurs.

• The Speculator – Is someone who aims to profit from future price movements in the markets. Speculators range from seasoned professional traders and fund managers through to members of the public, who normally buy and hold onto stock for longer periods in the belief that its value will increase.

THE MECHANICS OF SUPPLY AND DEMAND

Most things we buy from day to day have a relatively fixed price, at least in the short term. Generally speaking, if you walk in to a newsagent and begin to haggle over the price of a chocolate bar, the shopkeeper will most likely be unimpressed.

But this isn’t always true.

As a raw chicken approaches its sell-by date a supermarket may reduce its price. Has the chicken’s value really changed? The reason the price has been lowered is because the supermarket perceives that there will be less demand for a chicken that is nearing its sell-by date. If you were to buy this chicken you would in a sense be speculating: you make a purchase because you feel that, although demand for the chicken has reduced amongst the other shoppers, you’re sure that its true value is just the same – it’s just as edible and tasty as when it first hit the shelves a few days before.

But would you buy the chicken a day after its sell-by date? Maybe you will think ‘this chicken has been in a chill cabinet, this shop has a reputation for quality, sell-by dates tend to be fairly conservative, the price has been reduced still further, and I once bought a chicken past its date before and I didn’t get ill’. In other words, you’d be weighing up price against perceived risks.

If you go to another supermarket selling identical chickens from the same farm, the price might be slightly less. Why? The second supermarket is keen to attract your custom and is willing to sell the chicken to you for a lesser price. The price is determined not just by how much customers want to buy a chicken, but by how much the supermarket wants to achieve a sale.

Suppose that you go to a market in Marrakech to buy a chicken. There will be no ‘fixed’ price, and you will be expected to haggle with the seller until a price is agreed upon – an amount at which the stall owner is willing to sell, and at which you are prepared to buy. Each of you will probably enter the negotiation with some fixed levels in mind. The seller will have a minimum amount that he is willing to accept (perhaps the price he has paid for the chicken plus a percentage mark-up on his costs), and you will have a maximum amount you are willing to pay (perhaps what you paid for a chicken last week, or how much a supermarket would sell the same chicken for).

So we can start to draw a few important ideas out of the above scenarios:

  • Both the demand for a product and the readiness of supply will affect the price of that product at any given time.
  • There may be a difference between the perceived value of an item, and its actual intrinsic value.
  • When we make judgements about price, we often make judgements about risk.
  • Exactly the same item may vary in price from one seller to another.
  • Price is not always fixed, and can be discovered by the point at which the expectations of buyers and sellers meet.
  • Where price is not fixed absolutely, there will be certain points above and below which it is unlikely to move.

Unlike a chocolate bar in a newsagent, the price for all the commodities, currencies, stocks, shares, contracts, and bonds with which traders concern themselves (each of which is known as an INSTRUMENT or SECURITY) are radically un-fixed in nature. Because of this, the price that you see quoted on your screen at any given time is said to be ephemeral (i.e. short-lived or transient). All of the factors just discussed affect and determine price on a split second basis.