Who trades: market participants

Every trade has two sides. When a farmer sells next year's wheat at a fixed price, someone else agrees to buy it. Who would want to, and why? Knowing who is on the other side of a trade is the first step to knowing where the risk ends up.

Markets are crowded with banks, funds, companies and individuals. A useful way to sort them is not by who they are but by why they trade. There are five main motives.

• HedgersA trader who uses the market to reduce a risk it already has from its business or investments. already have a risk from their business, and trade to reduce it. An airline worries that fuel will get dearer; a farmer worries that wheat will get cheaper.
• SpeculatorsA trader who takes on risk on purpose, to profit from a view on where prices will go. take on risk on purpose, because they expect to profit. The word sounds negative, but speculators are often the ones willing to take the risk hedgers want to shed.
• ArbitrageursA trader who profits from prices that are out of line, by buying the cheap one and selling the dear one at the same time. look for the same thing priced differently in two places. They buy the cheap one and sell the dear one, and in doing so push the prices back together.
• Market makersA firm that stands ready to buy and to sell, quoting both prices, and earns the gap between them. stand ready to buy and to sell at any moment, quoting both prices. They earn the spreadThe gap between the price a market maker will buy at (bid) and sell at (ask). between them, and in return give everyone else liquidityHow quickly and cheaply you can trade without moving the price much.: someone to trade with right now.
• End investorsAn investor, such as a pension fund or a household, that buys to hold for a long-term return. buy to hold, for years or decades: pension funds, insurers, sovereign wealth funds and households saving for retirement. Most of the world's savings belong to them.

Two questions tell the five apart: how long does the trader hold the position, and does the trade add risk or remove it? Click around the map.

One market, every role

Here is how the five meet in a single market: futuresA standard exchange-traded contract to buy or sell something at a set price on a set future date. on wheat, traded on the Chicago Board of Trade. A futures contract fixes today a price for wheat delivered later.

Roles, not job titles. A large bank can make markets for clients in the morning, hedge its own loan book at lunch and take a view on the yen in the afternoon. When you see a trade, ask what it is for. That tells you which role is being played, and whether risk is being reduced or taken on.

The farmer sells futures on 50,000 bushels at $6.00. One CBOT wheat contract covers 5,000 bushels, so she sells 10 contracts. Prices are in US dollars per bushel. To keep it simple, the futures price and the cash price are equal at harvest, and fees and margin are ignored.

Regulators treat these roles differently. In US commodity futures, the CFTC sets limits on how large a speculator's position may be, while genuine hedgers can apply for exemptions. The EU applies position limits to commodity derivatives under MiFID II. Market makers on many exchanges sign agreements that oblige them to keep quoting, in return for lower fees.

Looking ahead: the institutions behind these roles, from banks to hedge funds and pension funds, are the subject of Module 1.2.

• Sort participants by why they trade: hedgers, speculators, arbitrageurs, market makers and end investors.
• Hedgers reduce a risk they already have; speculators take risk on purpose and often take the hedgers' risk.
• Arbitrageurs keep related prices in line; market makers keep markets liquid and earn the spread.
• End investors, such as pension funds, insurers and households, hold most of the world's savings and most of its long-term risk.
• Roles describe trades, not firms: one bank can play several in a day.

Hedger

A trader who uses the market to reduce a risk it already has from its business or investments.

Speculator

A trader who takes on risk on purpose, to profit from a view on where prices will go.

Arbitrageur

A trader who profits from prices that are out of line, by buying the cheap one and selling the dear one at the same time.

Market maker

A firm that stands ready to buy and to sell, quoting both prices, and earns the gap between them.

End investor

An investor, such as a pension fund or a household, that buys to hold for a long-term return.

Futures

A standard exchange-traded contract to buy or sell something at a set price on a set future date.

Position

What a trader currently owns or owes in a market. A long position gains if the price rises; a short one gains if it falls.

Spread

The gap between the price a market maker will buy at (bid) and sell at (ask).

Liquidity

How quickly and cheaply you can trade without moving the price much.