Trading

Investment Banks have a division called “Sales and Trading”. This division has many types of roles but we will focus on the traders on the trading floor aka “sell-side traders”.

A trader at a bank has these main responsibilities:

1. Provide advice to clients on a range of topics like stocks, bonds, market conditions, execution of trades, etc.
   • An example of a type of client a sell-side trader might have is a Hedge Fund, or an Investment Manager.
2. Work with clients to buy or sell stocks/products
   • Sell-side traders primarily work with their clients to buy and sell products in the financial markets that they might have trouble doing themselves. 
   • With each trade that they help their client execute, the sell-side trader collects a commission. 
3. Manage their own “risk” in the best way possible.
   • Often times, sell-side traders will help their clients complete their requested trades by directly trading with their client. When the trader does this, they are agreeing to take on the risk that comes with making a trade (if you buy and the price falls after, or if you sell and the price rises after).
   • Sell-side traders need to make sure that they are managing their own inventory (the products they own) appropriately, and making money on the different products they hold on to overtime.

Sell-Side Trader Tasks, Simplified:

Example: If a client (perhaps someone that works for a hedge fund) tells a sell-side trader he/she wants to buy some shares of Apple, the sell-side trader is responsible for getting Apple stock for his or her client. The sell-side trader will be paid for their efforts in the form of a commission. The trader must obtain the stock in the most cost-efficient way possible (because if they don’t, they risk losing the client in the future). What does cost-efficient mean?

Cost-efficient can mean a lot of things, but some examples might include:

• Getting a trade executed at the best possible price
• Following specific rules/criteria on an exchange so you do not pay high fees (don’t worry too much about this for now)

What are the ways to execute the client’s trades/order flow?

There are a few ways to help a client complete their trades. One simple way is to go to the public stock markets and buy the requested amount of shares for the client.

This can be done in several ways but three examples are:

• If the client wants to buy a product and the bank already owns the stock/product (since they bought it beforehand and have been holding onto it) they can simply sell it to the client.
• The client wants to sell a product, the sell-side trader can buy it from their client and manage the risk of owning that stock as they see fit.
• If the bank does not own the stock/product, they can go to the public markets and purchase it. Then sell it to their client (usually for an additional fee).

Like all traders, a sell-side trader’s goal is to make as much profit as possible. They can do this by managing their risk (and hoping the stocks and products they own increase in value over time) and/or collecting a commission from helping out their clients with their needs. Clearly, their relationship with their client is important since they want to continue to have their business and make commission in the future.

Proprietary Trading

“Prop Trading” is trading using internal (your own) money/capital. This means that the traders do not have clients, instead they are trading money that belongs solely to the firm they work for. Many larger institutions may have a prop trading division, but there are also prop trading firms whose core business is to trade internal capital and try to maximize profits.

Different Prop trading firms specialize in different types of trading strategies and/or different types of products. Prop traders will use a wide variety of tools/strategies to help them decide when and how to best buy and sell product to maximize profits.

Some Types Of Prop Traders:

You might see proprietary trading firms identify themselves as:

• Quantitative Trading Firms – using mathematics and/or computer science to help make trading decisions (when and/or how to buy and sell).
• Market Makers – one that always publicizes a price they are willing to pay for a product and a price they are willing to sell that product. Actively trades and tries to make small profits many times per day.
• High-Frequency Trading Firms – Firms that invest heavily in high-speed trading technology to allow them to receive and respond to data as fast as possible, and execute trades based on that data.

A prop trading firm can be none, one, or more than one of the above types. For example, there are many prop trading firms who consider themselves “High-Frequency Traders” and “Market Makers” (aka they make markets at very high speeds). 

The main difference between Prop trading and other types of trading is that there are no clients, and less restrictions on how you can trade. For example, Banks technically are not allowed to participate in “prop trading” activity due to heavy regulations in place.

The goal in prop trading is simple, make as much profit as possible while also managing your risk responsibly.

Hedge Fund Trading

While trading at a Hedge Fund can take on many different forms, most commonly these traders are Execution Traders. They are responsible for executing the trades decided by the Portfolio Managers or Research Department of the Hedge Fund in the most cost efficient manner.

Usually, if a hedge fund decides to trade a certain product, that decision does not come from the traders, but rather the Portfolio Managers and/or Research Department.

The trader’s job is to make the trade actually happen, and monitor how the markets behave throughout the day (to decide when to best make a trade and to watch how past trades are performing). Like traders at a Bank, Hedge Fund traders are trying to trade in the most cost efficient manner, however, in the case of a Hedge Fund trader, the motivation is to save their own hedge fund money on trade execution costs, rather than directly executing trades for clients.

As mentioned earlier, Hedge Funds sometimes have “prop trading divisions”, but for the most part the traders that work at Hedge Funds focus on execution and managing risk.

Commodities Trading

Commodity Traders can work at many different types of financial firms. However, not all traders work at Finance based institutions. Let’s explain this using an example:

Let’s say I am a Natural Gas (the gas that heats your home) Trader for a retail Energy Company. My job is to closely follow the Natural Gas commodity market and have an understanding of how it should or should not be priced. With this knowledge, I can help decide a few things for the company, such as:

1. The best time to buy Natural Gas from the suppliers
2. The price to buy the Natural Gas from the suppliers
3. How to manage the risk of owning an asset (Natural Gas), which is constantly fluctuating in price. Will need to manage this and “hedge” (or lessen) your risk daily.
   • For example, if I own some amount of natural gas, and you told me the value of natural gas was going to fall, I might want to sell some natural gas at a higher price today. I would now own less natural gas, and thus have lessened my “risk” or “exposure” to declining prices.

Example of a risk a commodity trader might have:

An example of a risk that could come up for a Natural Gas trader is “weather risk”. 

What is “weather risk”?

• In the winter, more people use natural gas to heat their homes and thus there is more demand for natural gas
• With more demand, the price of natural gas tends to rise. 
• However, if winter is colder than expected, demand will decline and the price of natural gas will fall. 
• It is important for a Natural Gas trader to anticipate this and make sure his/her company is not holding too much natural gas reserves that will now fall in value and be costly.
• The “risk” for the trader, is that the weather will change (in a way he/she did not expect) and he/she will lose money as a result.

What kinds of tools does a trader use? 

• Financial Analysis: of a Company to decide when they believe a product is under/overvalued. Buying when undervalued, selling when overvalued.
• Quantitative models: can be designed to help predict the price of a product at a future time. Buying if the model tells you the price will increase and selling if the model tells you the price will decrease.
• Systematic/Automated Trading Systems: can be created to allow a trader to be relatively hands-off. The system automatically makes trades based on certain signals/triggers that arise in the markets throughout the day. This can help traders make decisions more quickly/efficiently because the system automatically reacts to signals and does not have human error/delay.
• High Frequency Trading (HFT): a specific type of automated trading system, which makes trades electronically at very high speeds. The goal is to make trade executions before others get to do it. This is accomplished by spending lots of money to build fancy technology that can receive, process, and react to data faster than anyone else.

How to become a Trader:

Accomplishing these goals can be very difficult, and depending on the type of trader you are, some skills might be more helpful than others.

Here are some helpful skills (in no particular order):

• Understanding the product you are trading (how to price it and how the specific market for your product tends to behave)
• Quantitative Skills (mental math, probability, statistics, etc.)
• Programming Skills (data science languages mainly, to help analyze historical market data or understand trades you have made)
• A competitive, problem-solving mentality 

Typical Trader Hierarchy:

• Trading can be an emotionally stressful job since there will be great days but many bad days (lose money, make bad trades, etc). In general the work of a trader is very results-oriented. 
• While the pay can be very generous for strong performers, the turnover (especially in prop trading) can be notoriously much higher than most jobs. Poor performance (or lack of good performances, in some cases) often leads to being laid off. 
• Although some people see it as a positive, it is hard to hide behind your peers and be laid back during work. If you do not perform or provide value, people will quickly see that. 

With that being said, being in a highly competitive field can be challenging, but can also be equally rewarding.

What are the benefits of being a trader?

• The work-life balance of a trader tends to be quite good, compared to many other finance jobs. 
• Traders usually work “market-hours” (930am-4pm EST) plus a few more hours before and/or after. 
• While some trader firms are more competitive or more academic than others, you can get exposure to some brilliant minds. Many (quantitative) traders have mathematics and/or computer science backgrounds and decided they would rather apply their skills to analyzing the financial markets rather than going into a tech-related role or continuing with higher education. 
• If you are a successful trader that brings a lot of money to the firm, bonuses can be very large. The traders that tend to make the most are ones that “take risk” or make trading decisions themselves, rather than executing trades.
• For traders at banks, they deal mainly with clients and take on less risk, so they have less turnover (lay off fewer people). Additionally, a potential benefit to their role is they build strong relationships with their clients.

What is a typical Trader’s Salary?

A typical trader’s salary varies greatly depending on where you work, what your seniority is, and how you perform. An entry-level trader can typically make a total compensation ranging anywhere from $70,000-$300,000, depending where you work. While some proprietary trading firms pay even more than this, it is only a small percentage. 

If a top performer, a trader’s salary (usually from bonuses) can increase very quickly. Some firms (mainly prop trading firms) may even pay top performers 7 figures within 5 years, in an attempt to retain their top talent. Prop trading tends to be higher risk, higher reward.

According to wall street oasis, a typical Sales & Trading compensation projection at an Investment Bank looks as follows:

• Analyst: $80k – $150k
• Associate: $180k – $250k
• Vice Presidents:  $300k – $500k
• Managing Directors/Partners: $1mm+

Should I become a Trader?

Trading certainly isn’t for everyone. Trading can be a very competitive industry, as many firms are competing in the same marketplace trying to accomplish the same goal: make money.

However, if you enjoy following the markets and/or enjoy using quantitative/programming skills to help you problem-solve, trading might be a role you should consider.

Trading is considered a zero-sum game because for each trade there is a winner and there is an equal loser. While not everyone can be successful in the long run at trading, if you find yourself doing well it can be a lot of fun and very rewarding.