Page 145 - DCOM510_FINANCIAL_DERIVATIVES

Financial Derivatives

Notes Scalpers rarely hold a position overnight and often don’t trade or make predictions on the future
direction of the market. Locals and market makers often employ a scalping strategy, which is
the most common source of market liquidity

Notes Many scalpers like to concentrate on the sharp movements which frequently occur
in the currency market. In this case, the aim is to exploit sudden changes in market liquidity
for quick gains later. This kind of scalping is not very much concerned about the nature of
the market traded, whether prices are trending or ranging, but attaches great importance
to volatility. The purpose is to identify the cases where temporary shortages of liquidity
create imbalances that offer trade opportunities.

Example: Let’s consider traders of the EURUSD pair. In most cases, spreads are tight, and
the market is liquid enough to prevent any meaningful gaps in the bid-ask spreads. But when,
for whatever reason (often a news shock, but we don’t concern ourselves with the cause here),
liquidity dries out, and a significant bid-ask gap appears, the quote will be split into two distinct
pieces of data: the bid is, let’s say 1.4010, while the ask is 1.4050. A very short while, the bid-ask
spread will narrow, and the price will gravitate rather hastily to one side. Scalpers use these
very fast fluctuations for making quick profits. Right after the price has moved up to 1.4030, and
the bid-ask spread has narrowed to normal levels, a scalper may sell, for example, and as
volatility takes the price lower to, 1.4020, he closes his short position to open a long one, and so
on. The point is to profit from the emotional reactions of the market by remaining calm, and
betting that behind the sound and fury, there is nothing of significance, at least for the immediate
term.

Day Traders

A day trader is similar to a scalper in that he or she also typically does not hold positions
overnight and is an active trader during the trading day. Day traders trade both off and on the
floor. A day trader makes fewer trades than a scalper, generally holds his positions for a longer
period of time than a scalper, and trades based on a prediction on the future direction of the
market. Proprietary traders, locals and public traders are often day traders.



Caselet A Trader Thinks the Yen will Appreciate in Value

Versus the Dollar (USD/JPY is at 108.65)

he price of the dollar-yen is dropping and is currently at 108.65. A day trader gets a
sell signal based on his trading strategy. He sells 100,000 USD (1 lot) at 108.60 and
Treceives 10,860,000 Japanese yen. Assuming a 2% margin requirement, the deposit
would be 2,000 dollars. Right after placing his trade, the trader places a stop loss of 30 pips
based on his day trading strategy. The trader was right and the yen appreciates versus the
dollar (dollar loses value relative to the yen), pushing the exchange rate down to 107.50
yen at Satisfied with his profit, the trader sells the 10,860,000 yen at 107.50. He receives,
10,860,000 yen at 107.50 = 101,023 USD. Since he had originally paid (sold) 100,000 USD for
the yen, his profit is 101,023 - 100,000 = 1,023.

Source: http://www.mydaytradingtutor.com/currency-trading-examples.htm

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