Finding a trading style that works for you is just as important as finding a trading style that works.
What Kind of Trader are You?
I think of trader types as being on something like a specturm; it’s oriented along timeframe. In my risk framework, we discussed diversification versus focus. Then a few weeks ago we talked about mean reversion and trend. Along each of those dimensions we can also apply timeframes.
When we apply the dimension of time-frame, we start to see a division of trader types into four broad categories. Understanding what type of trader you are can help you clarify your research, focusing on things that add value to your particular style of trading.
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The first category is investors. Investing tends to be long term, and investors tend to be fundamentals driven. The intent is to participate in the long run success of an enterprise, or to capture specific designated cash flows (in the case of fixed income investors). Investors are always directional — they have an investment thesis that a stock will benefit from the success of the underlying business.
In the case of crypto, if you ignore shorter time price movements, but HODL for the long term to benefit from the inevitable success of your chosen projects, then you’re an investor.
Investor mantra: when in doubt, zoom out
The majority of traders think that they are investors, but are actually speculators. If you pay attention to price in any meaningful way, trying to time entries and exits, then you’re a speculator.
Speculators are directional traders - you expect price to go up so you buy. You expect price to go down so you sell short. Speculators tend to be shorter term. Rather than focusing on the long term success or what the potential cash flows might be, a speculator is looking to capture changes in price based on particular events that are going to play out over a particular timeframe.
You could buy bonds because you need the cash flows every year, and that makes you an investor. Or you could buy bonds because you think the interest rates are about to go down, and if interest rates go down the price of bonds will go up. You’re speculating that the price of bonds is about to change, and that makes you a speculator.
Did it bottom yet? Potential long? Still a good short? Who knows!
Market makers maintain an inventory so that they can continually update trade offers on both sides of the spread. If you read our discussion on order books and market makers from two weeks ago, you may recall that Liquidity Providers (LPs) in decentralized exchanges (DEX) are also market makers.
Market makers in order books typically use trading algorithms to adjust their orders automatically and keep offers on both sides of the trading book. Since they are about profiting from trading volume (capture the spread as many times as possible in a given time interval) the market maker time-frame is very short-term, and it is considered ‘inventory risk’ to get caught holding something for an extended time period. LP’s in a DEX also face inventory risk, but in DeFi it is usually referred to as ‘impermanent loss’ (IL).
In both DeFi and traditional finance (TradFi), there may be offers in place to encourage market makers to support liquidity in particular markets. In DeFi, yield farming incentives for LPs are quite common, but LPs would usually earn a share of trading fees as well. In TradFi, liquidity providers pay lower trading fees and may even earn trading fee kickbacks. The incentives they receive are tied to either trading volume or order volume, depending on the incentive program.
Given the composability of DeFi protocols, investors in multiple tokens may become market makers and use yield farming programs to capture cash-flows on positions that they are otherwise holding for the long-term. There is some IL risk still, but if you are bullish on all of the tokens in a liquidity pool (BANK-ETH for example), then keeping your holdings balanced to a target ratio while being compensated with yield farming rewards can be an effective strategy.
If you are NOT bullish on all the tokens in an LP, then market making requires very active management. A quick drawdown in one token can quickly erase months of yield farming rewards!
A few weeks ago I posted about Mirror Protocol. The most common strategy engaged in by people using Mirror Protocols is a market maker strategy called ‘Delta neutral’ yield farming. ‘Delta’ is a measure of your exposure to directional moves in the underlying asset, so ‘delta neutral’ means that you have balanced your long and short positions to minimize market risk and capture liquidity rewards.
The longer it stays in range, the more market-making profits I can capture!
The idea of arbitrage is that you take opposite sides of a position, usually on different exchanges (or opposite sides of a closely correlated position) with the expectation that a mispricing will be eliminated. When the mispricing is eliminated, you can capture the profit. Arbitrageurs are actually timing agnostic, but they would prefer a quick turnaround to free up their capital for other arbitrage trades. In arbitrage, you’re not directional, you are expecting a mispricing to correct itself and hedging your bet so that you can ride out whatever timeframe it takes for the mispricing to correct itself.
In crypto markets, the most common type of arbitrage is taking advantage of mispricing events between exchanges. Because crypto tokens are traded on so many different exchanges, there are often pricing differences between exchanges. If you just buy on one and sell on the other (or short if you don’t have any inventory), then you can benefit from those mispricing events.
We can see that time-frame and intent have a big impact on what type of trader you are. When you consider mean-reversion, trend, and risk management in light of different time-frames, you see that there are an unlimited number of potential strategies. That makes trading super interesting and fun because there’s always more to learn!
Finding a trading style that works for you is just as important as finding a trading style that works. Period. There are lots of trading styles that work, but not every trading style that works will work for you. It depends on your circumstances, available capital, and personality.
I hope that you have found this informative, entertaining, and educational! If you did, please subscribe, share on social media, and forward to another trader - whether investor, speculator, market maker, or arbitrageur.
Not financial or tax advice. This newsletter is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. This newsletter is not tax advice. Talk to your accountant. Do your own research.
Disclosure. From time-to-time I may add links in this newsletter to products I use. I may receive commission if you make a purchase through one of these links. Additionally, the Savage Corner writers hold crypto assets and actively trade in certain markets.
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