Motivations to Trade
The most obvious reason why traders trade is to make a profit.
It's not the only reason, but it's a big one. And getting the right trade at the right time requires the right flow of information. Would you expect active traders to generally want their trade information to be hidden or advertised?
Yes.
Generally not; they like to keep things hidden.
This is why it's common to split up trades or choose markets with less transparency. Lit markets are very transparent, while dark pools are not. Which do you think is more likely to have a given order filled?
No, orders are filled most frequently in transparent markets.
Exactly.
If you want to hide your position, it makes it harder for other traders to find you. An opposite order would have to be placed in a dark pool before an order expires, leaving many unfilled. This can be a problem for traders requiring trade urgency. A trader focusing on a particular event will often need to execute the trade quickly to avoid "alpha decay," which is the loss of potential alpha from a profitable decision due to the time it takes to complete a trade.
A second motivation to trade beyond just profit seeking is risk management. What attribute would you most closely associate with this motivation?
Right! Sometimes this is just simple portfolio rebalancing, or other times there are specific risks that a trader is looking to hedge with offsetting positions.
No, this generally refers to taking equity exposure with cash in some way.
No, this is closely tied to the profit-seeking motive.
Perhaps a trader is looking to tilt the beta of a stock portfolio. What would probably be the most cost-effective market to consider?
Unlikely. This could be a diversifier, but the manager probably wants to maintain the equity exposure.
Not really. This would certainly accomplish the job, but not in the most cost-effective way.
Absolutely. There's a lot that can be done with a futures position, and they are so liquid that they make a great choice for hedging and rebalancing. Of course other derivatives are also inexpensive and useful depending on the risk profile. These often come with leverage, and leveraged positions must be carefully monitored.
Beyond seeking profits and mitigating risk, sometimes you just need to have some cash, or actually have less. Cash flow needs is a third main motivation to trade. Suppose a trader was worried about cash drag. Would the trader essentially be trading to have more cash or less?
Actually, the trader would want less.
Of course.
Cash drag is the near-zero return that cash offers. It can be equitized by taking equity futures positions equivalent to the cash on hand to avoid this. Or if the problem is a lack of cash due to margin calls, then of course the trader will be looking to sell holdings in order to generate the cash needed.
Finally, there are corporate actions. There may be mergers or spin-offs that require a portfolio manager to make trades in order to account for these changes.
To summarize:
A primary motivation to trade is profit seeking. Trade urgency refers to the speed at which trades are needed to avoid alpha decay. Other primary motivations include risk management (such as hedging), cash flow needs, and corporate actions.
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