How The Market Works
Updated: Aug 25
The financial ecosystem is made up of players of all sizes. The top dogs are the institutions; they control and manage the most amount of money. They often invest in such large quantities that they can affect the price of the stock they are investing in. Examples of these include mutual funds, investment banks, hedge funds, insurance companies, etc. They manage money for a pool of people and invest large quantities at a time.
How Institutions Choose Their Investments: Institutions predict how much money any given asset is going to make each year in the future, then assign that sum of money a value in the present day. If the current price of that asset is less than the value they assigned, then they make the investment.
Their investments are so large that they often affect the price of a stock as they enter or exit the position. And as the price moves, smaller players capitalize on the difference: day traders.
Day traders are smaller, nimble traders that often use algorithms to make trades on their behalf. They use a multitude of different strategies, and while all are fairly complex, they generally concern measuring the difference between the current price and the average price over a period of time. They understand institutions are the big players, and that the institutions can quite literally move the market price day-to-day, and day traders will make small yet precisely calculated trades based on very slight movements in price.
And then lastly we have retail investors. These are individuals making investments from their own personal account. There are millions of retail investors across the world moving smaller sums of money and unable to move the market individually. Occasionally retail investors can band together to push stock prices higher, similar to GameStop or Dogecoin, yet this is rare.
Retail investors have the least amount of access to research, which usually leads them to making bad investment decisions individually. The average retail investor generally outperforms the average day traders only because the day trader makes trades more frequently, giving them a higher probability of making a bad investment and losing money.