3 Types of Traders

I am obsessed with studying the structure of markets (I never said I was normal!). I would like to share definitions of the three basic types of traders that compose every market. These definitions are influenced by countless academic papers and boiled down for your convenience. This effort is driven by my belief that every individual alive would be interested in this subject if they had the fundamental building blocks of understanding.

It all comes down to information - The most valuable commodity.

1. Informed traders. Informed traders transact (buy and sell assets) with the valid belief that the 'true/efficient' market price is dislocated from the actual market price (generally quoted as the last buy/sell exchange). If an investor has studied a company or asset in-depth and holds the justified conviction that an asset is under/over-valued then he can profit when the asset returns to the 'efficient' price. Foresight is key here because the basis for informed trading is issuing directives to trade (bid/asks) informed by information not reflected in the actual market price. The paradigmatic informed trader is Nathan Rothschild who had advance knowledge of the outcome of the Battle of Waterloo and was keenly aware of the implications this victory would have on the British Stock Exchange. https://en.wikipedia.org/wiki/Nathan_Mayer_Rothschild#Waterloo_legend

2. Uninformed traders. The vast majority of humans and investors who do not devote their full time and talents to discovering dislocations in markets fall under this category. Uninformed traders do not trade on any unique information. The word 'uninformed' is not derogatory in this sense - it simply means what it says: issuing directives to buy/sell without the type of information possessed by informed traders. The paradigmatic uninformed trader is a manager for an index fund. These traders issue directives to buy and sell based on apparent facts like which companies are included in a certain published index (e.g. the S&P 500).

3. Mistake traders. This is the only group of traders that is guaranteed to lose money. Mistake traders issue directives to buy and sell based on the mistaken belief that these directives are informed by information not represented in the actual market price. These people are the main source of wealth shifting to the informed traders.

Closing thoughts. You may have heard the expression: "Bulls make money; bears make money; pigs get slaughtered."

It should be clear now how "Informed traders can make money; uninformed traders can make money; mistake traders get slaughtered."

I love reading comments - especially any insights or points that were unclear. I relish the opportunity to improve and communicate better with everyone here.