As a new investor sometimes learning the lingo can be just as daunting a task as investing. With so many different terms that aren’t used in standard conversation learning what everything means is much like learning a completely new language in many ways. The better an investor learns these new words the easier investing is going to be for them. Not to mention, knowledge is critical when it comes to any type of investment. Knowing more about how investments and the investment world function can mean the difference between making a profit and taking a heavy loss. More often than not the less experienced investors are the ones that make bad moves that could have easily been avoided by just knowing more about what they are doing.
One of the most important things to know about investing is the difference between the many different parties involved in a transaction. This is obviously a very basic concept but one that is important for anyone looking to invest, especially in the stock market to really understand in order to be effective. There are a couple major players in a market, the market maker, the broker, and the investor. It is important to understand the roles of each and how they ultimately impact the overall transactions process and the market as a whole.
The market maker is the one that sets up the market and processes all transactions for the broker, the broker handles all trades and gives investment guidance, and the trader is the one that does the actually investing. This is the basic rundown of how the market functions. Brokers are also capable of trading stocks for the brokerage and market makers are also known for making transactions for their own house. The more important understanding can be made by comparing the types of investor and the types of broker to better understand the different roles in investing.
TYPES OF INVESTOR
Far too often there is a confusion as to what to call an investor. This is determined mostly by what they actually do with their money and how they invest it. As everyone invests in a different manner there are different terms in order to describe each investment strategy. Keep in mind that anyone could actually be multiple different types of investor at any given period of time.
Investor or Long – An investor is someone that is typically going to have money sitting in a 401k or will put money into a stock for a longer period of time (over a year). This person is more than likely going to be very passive in the management of their account and will often times invest only in safer investments with companies that have a long standing. A typical long is going to avoid the extremely high risk pink sheet stocks.
Daytrader or Flipper – This is an investor that will normally trade a stock daily. Most daytraders are called flippers because they are often times going to buy a stock and sell it in the same day. Many times they will sell the same stock numerous times in the same day that they purchase it taking advantage of small gains. By flipping the investor hopes to make small but quick gains to create a larger overall daily profit. This is a very time intensive method of investing that involves a great deal of research and charting in order to determine when the best entry and exit is throughout the day. Normally a daytrader is going to take advantage of press releases in order to create additional volume and price increases.
Trader – A trader is simply someone that has a mixed strategy. They are able to day trade a stock as well as hold for a longer period of time. They are simply looking for the best possible return on their investment without taking on a great deal of risk. Often times the trader is going to hold a stock for a weeks at a time at most and will rarely hold long enough to be considered a long.
Short or Speculator – A shorter is someone that is betting against a company. They believe that a stock is going to go down so they place a trade called a short sale. In this transaction, they are literally selling borrowed stock that they will promise to buy at a later date. The hope is that the stock price will go down and they can buy (short cover) at a later date at a significantly lower price. This is a completely different strategy of investing than most people participate in on a daily basis, but a necessary part of the stock market in order to keep stocks from running out of control. Shorts take on a huge risk as they could potentially have to pay considerably more for a stock than they had intended. There is no limit to how much a short can lose while a typical investor is only limited to what they invest initially.
There are many other types of investor as well, but in effort to keep this guide to a more beginner to intermediate level I’ll leave out equities, bonds, funds, options, etc. It takes a great deal more knowledge to start investing at that level and it is important to first educate oneself before a move is made to invest in the higher knowledge based investments.
BROKERS AND MARKET MAKERS
Brokers and market makers are a little easier to explain than the types of investors as there are only a few basic concepts when it comes to the broker and market maker. They are however, the most important aspect of the trading sequence as they control the flow of the market.
Brokers, Brokerage, Investment Firm – A broker is simply the person in charge of a brokerage. They are the ones that sign off on transactions that the investor places. The broker will often times have investment advisors below them that are able to talk to investors about different investment options but they are ultimately responsible for transactions and investments within a brokerage. E-trade, ameritrade, and scottrade are good examples of online brokerages. These companies have physical locations but operate online which allows customers to have more direct control of their investing. Other brokerages require phone calls to the broker or investment advisors in order to make new investments. The brokerage maintains accounting for individual portfolios and provides a variety of investment related services.
Market Makers – A market maker is the company that actually handles the transaction. They essentially make a market for shares that are being bought or sold. While market makers have received a bad reputation for market manipulation by holding buys and sells to their own benefit, they are in place in order to give a more organized approach to trading. A broker places the order with a market maker who then finalizes the transaction.
BRINGING IT TOGETHER
To summarize an investor comes in many varieties. They are different from a broker as they are the ones that are spending the money and the broker is the one making the spending of the money possible. All transactions go from investor to broker to market maker. The basic difference between the two is their order in the chain.