Easy Money On The Stock Market? Yes And No…

The elementary function of the stock market is risk exchange. Similarly to when you pay your car insurance and generate profits for the insurance company, the stock market is made of those who offer risk and those who take these risks for a premium.

The Premium Picking Business

If you are an investor, it can be assumed that you are willing to get exposed to some kind of risk for an expected return over your investments, right?

As an investor, you buy bonds, buy shares, buy REITs, sell options contracts, buy or sell commodities, and you do that because in the future if everything goes well, you will make money from these positions. In essence, you are taking a risk and charging for it.

The return you get is more related to the risk you assume than the amount of money you put on the market. Of course, if you take too much risk and you don’t have enough money to cover the eventual losses, you will be left out of the game at some point. There are ways to calculate how much risk you can take with an insignificant chance to be left out of the game (you can see an article that covers this by clicking here).

Diversification is the key! Diversification can be understood as a free lunch from the market. Considering that you have a premium over any position in your portfolio it is easy to realize that each time you add one new asset (low correlated) in the portfolio, the risk is reduced but the return is maintained. It is just like instead of selling insurance to one big ship, one could sell the same value in insurance for 10,000 popular cars. It is possible that the ship sinks but it is very unlikely that all 10,000 cars will crash.

In this perspective, whether an asset is cheap or expensive depends on a great part of you. It means that depending on your needs and your existing portfolio, one asset can be expensive for you and cheap for others, or vice versa.

In general, the risk taken on the market is not fixed. It varies all the time. However, with the increase of derivatives in the market, both in number and in liquidity, it is becoming easier to define a level for the risk assumed in the market.

For those who have patience and can assume some risk, this premium picking game is the way to make some easy money in the market.

Of course, there is the other side of the premium picking game. The ones that pay for that. In general, they are part of the productive chain. A farmer may need to ensure that the selling price of corn will be viable even before it is planted, or an industrialist may need to ensure that an input material is within a price range before producing a certain amount of products. Also, a company may decide to raise capital, making itself the product with a risk premium for the investors.

The Other Players In The Game

There are many players participating in the market, each of them trying to make money in their own way.

• The trading addicted and novice traders - These are people that get into the stock market seeking high returns in a short period of time. They make operations based on weak assumptions and sometimes are manipulated by big players that need liquidity for their operations. These traders act pretty much like gamblers, and most of them leave money on the table at the end.
• The speculators - These are players that are not happy with the level of returns in the premium picking game. Their idea is to bet on the price movement based on fundamental or technical assumptions or even instinct. Generally, it is not easy to systematize the decision-making process and the success in the speculation game depends on some kind of talent. They are like artists, there are many, but only the ones with talent or luck succeed.
• The service providers - Exchanges as well as the brokers receive commissions for the service they provide, usually through fees embedded in transactions made by the market participants. Market makers are a type of service provider that, actually, participates directly in the market, placing orders in the book. Their function is to generate liquidity for the other participants. The money they make comes from the spread on the price of assets, or in some cases, the exchange can offer some remuneration or at least some benefits, like commission-free trading. These guys are like the house on the gambling business.
• The arbitrageurs - If the Market was a casino, the arbitrageurs would be the card counters playing blackjack. Their intention is to make money from the system inefficiencies, so they are looking for anything that might be out of place. It can be as simple as being bought and sold on some asset trading at different prices in different markets, or complex, involving mathematical modeling, statistics, computer performance, network performance and etc. The kind of opportunity they deal with can be unique, when it happens only one time, or systematic when it happens repetitively over a period of time. Their actions are manifested in different forms, and in most of the cases, there is a market impact that makes this a competitive market, since the more people try to take advantage of the same market inefficiency, the lower the potential for gain.

The market ecosystem is very interesting. Many participants, each in their own environment, trying to make money in their own way, bringing the market to equilibrium and all together contributing to generate the thing that adds value and keeps the market in good working order, liquidity.

What about you? Which type of player is the most interesting for you?