Saturday, June 26, 2010

Opportunity in Equity Market Trading

Investment market as a game has two scenarios, namely zero-sum game and non-zero sum game. As a corporate participant, the game is usually a non-zero sum game as the equity is a long term investment or hedge against business operational consumption. As a conservative managed fund or individual investment, the game is usually stock trading as a long term investment seeking equity appreciation. These two categories of trader are looking for profit from equity appreciation in stock market or hedging risk in foreign currency fluctuation.

The third category of trader is speculative day trader who is seeking profit from trading arbitration. This is a high risk game since the movement of stock market is highly unpredictable in a relatively short time interval. The use of leverage will magnify the gain or loss in trading. The scenario looks more like a casino gaming with random occurrence of events.

However, stock market is not a completely random event. There are factors that render it some degree of predictability which can be exploited by participants of the game to take advantage over others. Firstly, stocks are driven by news and economic condition. There are many sources of information. The trader have to identify the sources and filter the information for accuracy. Secondly, the stock market has a long term uptrend. The intermediate term movement can be estimated with investor sentiment and market indicators. There is still plenty of uncertainty. But a well analyzed estimate will increase the probability of profit over loss. The short term movement is where the profit or loss of a speculative day trader comes from. It is a highly unpredictable event and the trader makes the trading decision based on intuition. Although it is difficult to predict the outcome, the game is played among people and thus the behaviour of people on market movement will have effect on the outcome. If such emotional behaviour can be estimated correctly to certain extent, the chance of beating the market will increase.

If above analysis of stock market mechanism is not significantly deviated from truth, then an individual trader that can exploit the competitive edge over the counter parties can make appreciable return from speculative stock trading. And this scenario appears to match with the objective of equity trading mentioned earlier. Thus the attempt to develop a trading strategy will be for speculative stock trading in later discussion.

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