10 November 2022
While professional traders/day traders are often criticised for creating short-term volatility in share prices, in reality, this is not the case. It is crucial that stock markets have a mix of short-term, medium-term and long-term investors to allow value to be unlocked. Consequently, the importance of day traders is something which observers often miss. So what exactly do they provide?
Liquidity is crucial whether you are looking to buy stocks and shares, commodities or any other asset. As a professional trader looking to take advantage of short-term opportunities, many people underestimate the impact this has on liquidity. The cumulative effect is enormous when you consider the number of day traders active in the market today. So how does this help?
A stock exchange is effectively an information exchange, a system which takes in an array of different views, helping to create “fair value”. Consequently, the more trades carried out in an individual stock, the greater the input and likelihood of arriving at the “right price”.
Where a stock is seen as relatively “illiquid”, short, medium and long-term selling pressure can heavily influence the public price. The same is true of short, medium and long-term buying pressure, where there is limited stock available. This can push share prices to levels that do not truly reflect the company's underlying value. The additional trading volumes created by day traders make a more reflective market, encouraging buyers and sellers and allowing markets to arrive at a more reflective price.
Institutional investors are, for many people, the backbone of the stock market, large investment companies looking to take long-term positions in a range of stocks. Due to the size of these investment funds, liquidity can be a significant challenge forcing many to back away from what could be lucrative stocks of the future. However, it is true to say that trading activity encourages trading activity which then enhances levels of liquidity.
As institutional investors become more involved, these companies are more attractive to analysts, which can help create company-specific research as we advance. This attracts more investors, media interest, and opportunities for newprofessional traders/day traders to become involved. Is it fair to say that the traders can, in many cases, light the blue touch paper to long-term institutional investment?
Before the introduction of online trading, electronic trading across the globe, and market interconnection, arbitrage was a relatively lucrative investment strategy for many. For instance, numerous large US companies traded on Wall Street and in London. Occasionally, these two different listing prices would fall out of sync, creating an arbitrage situation. The ability to buy and sell on different stock markets, whether through individual stocks or ADRs, eventually brought these dual listing prices back towards parity.
This is seen by many as the domain of professional traders/day traders, those focused on exploiting short-term pricing anomalies. Such blatant arbitrage situations are not as commonplace today after the introduction of low-latencyelectronic trading. However, they still emerge, and it is very often day traders who draw these prices back to “fair value”.
Professional traders and day traders bring a lot more to the investment party than many people seem to realise. The power of liquidity not only allows more efficient value-driven trading but also attracts the interest of institutional investors. This then opens the opportunity to raise capital on investment markets, grow businesses and enhance individual company reputations. If day traders were not constantly buying and selling stocks, can you imagine the impact this would have on trading volumes?
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