Market participants

Why is it important to know the market participants on the stock exchanges?

The market participants pursue different objectives. They also have different time horizons for their investment. For this reason, it is important to know the market participants in order to put yourself in the shoes of those who move the prices. Consider where certain market participants are forced to act in particular if you trade speculatively on the stock market.

All market participants have an interest in achieving the highest possible return at the lowest possible risk. Unfortunately, these two interests are entirely opposed to each other. On perfect markets, the investor will always receive the same return in return for a particular risk.

What market participants can be distinguished and what are they looking for?

1.) Institutional investors

Institutional investors can be banks, insurance companies, enterprises, or investment funds, to name but a few. These investors pursue different investment objectives. Clear interests cannot be defined here accordingly. It is important to realise that they move large sums of capital with this group of market participants, however. Daily market fluctuations are of no interest. The exact entry or exit plays a completely subordinate role as a result of this. Major trends or price developments are traded instead. Most trading decisions are made based on fundamental judgements or strategic considerations. Only parts are sent to execution when building and removing positions. Otherwise, the players would ruin their own courses. In particular small investors must be aware of this since one should not go up against the big capital. The major investors ultimately determine the direction of the market.

2.) Hedgers

Hedgers are market participants who have no interest in achieving a profit with their positions. Instead, they try to hedge their existing positions or risks. A mechanical engineering company, for example, is exposed to the risk of raw material price trends. The company can hedge against this risk and thus secure its own calculations. This company could, for example, build up long positions against rising commodity prices. If commodity prices actually rise, the costs for the respective company would increase, while profits would also be made on the futures contracts. If prices go down, however, costs would fall, but the long positions would produce a loss. This permits hedging against this type of price fluctuation.

3.) Speculators

Speculators always try to achieve profits on the markets, regardless of whether they rise or fall. They try to figure out where movement develops and will enter the corresponding positions. If they believe that prices will rise, they will buy long positions. Vice versa, they will buy, short positions. They thus try to achieve systematic profits regardless of the market situation.

4.) Central banks

A new group of players has entered the market with the central banks. Their task is ensuring price stability and supporting general economic policy. The central bank can both control the value of money and supply the economy with credit by varying the interest rate. However, central banks can also buy and sell securities. This is called open market transactions. Central banks have a decisive influence on the markets due to this. They move even larger sums of capital than the other institutional investors.

5.) Arbitrageurs

Arbitrageurs are market participants that try to make risk-free profits. They exploit valuation differences between certain asset classes. Thanks to the arbitrageurs, price differences can hardly occur on the markets, as they always ensure equalisation. Computers try to facilitate such arbitrage transactions in high-frequency trading today.

What level of information do the individual market participants have?

We first need to look at the information efficiency of the capital markets to know the level of information of the individual market participants.

In the case of complete information efficiency, the future cash flow or future cash flows would be priced into the prices of securities, as the valuation-relevant information is reflected in the prices. This requires all market participants to always have the same information at the same time and interprets it in the same way. In this case, the return on a securities portfolio would always generate the equilibrium return. In other words: the return on a securities portfolio can be drawn as a linear function of risk. There are no upward or downward outliers with complete information efficiency.

What consequences are there from complete information efficiency on the capital markets?

• No arbitrage transactions would be possible since there are no valuation differences between the securities. The group of arbitrageurs then would not exist.

• Excess returns would not be possible on the market. The systematic evaluation of information would be useless, as a securities portfolio would always generate the equilibrium return.

It is, therefore, quite clear that perfect information efficiency does not exist on the capital market. The level of information among market participants is not homogeneous, as information is not available free of charge on the market.