Trading as a Service: Unraveling the Market's Willingness to Pay
Decoding Risk, Liquidity, and Value Creation in the World of Trading
Introduction
In any traditional career such as accounting, engineering, law, medicine, etc, the professional is paid for their qualified service. The better you are at a specific job, usually correlates to the higher pay and opportunities that are available to you.
This is a known fact because the market has a need for your service. You are filling a gap in a market that requires your skillset in order to operate. And the market is willing to pay you an agreed amount to have access to your skills. That is edge.
But how is that applied to trading? Why is the market paying you as a trader to trade? What service are you offering?
This post is not about proven concepts but rather me thinking through this topic in a written format. I’ve not yet come up with a conclusion and so many logical mistakes might be made.
Trading as a service
If the market is willing to pay you for your services as an accountant, what is the market paying you to be a trader? What value do you bring to that market so that you can extract a profit?
The answer to this question seems to lie in the actions we take as traders. When we are buying or selling we are taking risk to ourselves. When we buy or sell an asset, we assume the risk of loss of capital. That is the risk that the trader is willing to take. But why would you take that risk? Who benefits from me taking a risk in the market?
Other market participants that are looking for that liquidity, at that particular moment, benefit from me providing them that liquidity.
As an example, Bitcoin is pumping and it seems to be going so fast that everyone wants to jump in and no one wants to sell. If no one sells , people can’t buy until price reaches a price so high that someone is willing to sell. When the trader steps in to sell, he is providing that liquidity for those eager buyers that want to buy as prices increase.
In the example above the trader provided that service. You sold shares to people that wanted. You could have done this two ways:
Trader 1: Selling shares you had previously bought at lower prices
Trader 2: Selling shares by shorting the market
Both of those traders took a few different risks.
Trader 1:
Risk: Buying lower in the expectations of going higher. The trader initially assumed the risk that prices might decline and in doing so generate loss of capital. Also when he sold that position, we can say that he assumed the risk of capping his gains. Loss of opportunity might be considered as risk even though not as imminent as taking the position.
Trader 2:
Risk: Shorting a fast moving asset is extremely risky because it can quickly go against you and even skip your pre-determined stops if there’s not much liquidity on where you want to exit.
Both traders took risk and at the same time provided liquidity to other market participants that wanted to take their own unique actions. The market is willing to pay the best liquidity providers for their services because they fill inefficiencies that most traders aren’t willing to fill because they are too risky.
Who has the knowledge and is willing to buy at lower prices before everyone else is buying, in expectation of higher prices? Who wants to take the massive risk of shorting a parabolic move and getting caught when prices keep moving against them?
The trader that is willing to take the most amount of risk at a certain period, is the trader which will get paid the most because he has not much competition. Of course assuming he has an edge.
How to apply this concept into an actual trading system
As in any career the trader must specialize in what he’s actually good at. It doesn’t mean he has to be good at one thing only, but the first step is getting profitable at one task. What service can you provide the market that makes it willing to pay you to participate? That is where your trading system comes on. What are you trying to exploit?
Arbitrage
Mean reversion
Momentum
Market making
In any category you must be above average good in order to come out on top of all the other market participants. There’s limited amount of capital available in the markets and the ones that extract profit are usually the ones that are extremely good at what they do.
They provide a service that is both efficient and valuable. And the market rewards them appropriately. You have to excel at the field in which you are specialized in order to get to the top of your trading.
There’s many dimensions to this and there’s some more complex than others. But what matters is that you need to know what is the service that you are providing to the market. The market ain’t gonna give you free money that’s for sure.