by Jerry Chi Comments (155)

What You Actually Do In Sales & Trading, Part 2: Equity Trading

What You Actually Do In Sales & Trading, Part 2: Equity Trading
Man Analyzing Financial Data and Charts on Computer Screen

While there are plenty of day-in-the-life and week-in-the-life stories detailing what you do in investment banking, there’s surprisingly little information on sales & trading.

We started to fix that problem by looking at what you do in fixed income – besides bankrupting your firm and causing the economy to spiral into a bottomless abyss.

This article will continue that thread by telling you all about equities, the second major area within trading.

Once again, Jerry’s the expert and the author here, so direct all questions to him.

Quick Recap

Trading is divided into groups depending on whether or not you have clients or you’re making your own decisions – agency trading and prop trading, and then the gray area of flow trading in between.

And then it’s also divided according to what you’re trading – stocks, bonds, currencies, or derivatives of those.

Originally Fixed Income was supposed to mean only securities that involved debt, but these days FX and commodities traders are often put under the umbrella of “Fixed Income” as well inside investment banks.

Similarly, “equities” originally just meant trading stocks of companies, but these days it has expanded to cover a couple different areas.

So let’s delve in and see what you do in equity trading besides gambling, eating junk food, and abusing interns.

Agency Trading

This is the most basic type of equity trading: you work at a sell-side financial institution, like a large investment bank, and you execute orders for clients throughout the day.

You don’t make decisions on what or how much to buy – you just take what the client wants and you make it happen.

Why do they need to go through an investment bank just to buy or sell stocks? Couldn’t they just use E*TRADE?

No – because of the size of the transactions.

Let’s say that a mutual fund wants to buy 1 million shares of Microsoft – if that order were placed immediately, it would be too big for the market to absorb and it would disrupt the share price by quite a bit if they attempted to buy all 1 million shares at once.

So it’s your job to divide this into smaller pieces and buy a portion at a certain interval throughout the day, or through another period of time – usually you follow a fixed schedule for buying the stock (e.g. every 20 minutes).

The only thing you control is how to vary the order timing and order routing – if you work in the US you have more control over these variables because of the sheer number of ECNs (electronic communication networks) and dark pools. In other markets you don’t have as many options.

Pros: If you’re interested in trading but you’re not quite ready for more advanced jobs, this could be a good fit to get your foot in the door.

Also, the work hours are much shorter than most other jobs in finance: you might arrive right before the market opens and leave right after it closes; there’s not much analysis to do since you’re not making your own decisions on what to trade.

Cons: The job itself can be boring at times, and you don’t have many exit opportunities. Also, more and more agency traders are being replaced by automated trading algorithms over time.

Proprietary Trading – Plain Vanilla Equity

NOTE: In theory, the Volcker Rule passed after the 2008-2009 ended proprietary trading for banks. In practice, however, banks can still use it for certain hedging activities, so it has not gone away completely, though it is greatly diminished.

Plain ol’ stocks. As cool as “synthetic collateralized mezzanine bespoke hybrid exotic derivatives structuring / trading” might sound as a job title, there are still plenty of benefits to being a normal stock trader.

This is the opposite of the agency trading discussed above, because you’re making your own trading decisions and there are no clients.

You don’t have to deal with too many logistical or IT issues that come with trading over-the-counter instruments, and the market liquidity is excellent in developed markets – so you don’t have to worry about not being able to exit your positions.

Bid/ask spreads are small, trading fees are low, and if you make a mistake you can even undo your trade immediately without much damage.

The only problem is that there are so many market participants that it’s very difficult to find great trading opportunities that everyone else has missed.

Usually you focus on a specific sector and you hold positions for a few days to several weeks; you normally do both micro- and macro-analysis, though there are some traders who ignore the fundamentals and just focus on technical analysis.

You don’t need to be a rocket scientist to do the job: you just need to be good with numbers and a quick decision-maker.

Pros: More interesting work than agency trading; better exit opportunities within trading; potential to make more money than agency traders.

Cons: Hours tend to be longer, especially if you need to do a lot of analysis; you could argue it’s still less “interesting” than trading more exotic securities.

Proprietary Trading – Equity Derivatives

There’s a smorgasbord of derivatives based on equities, but here I’ll just focus on the most basic one: options.

They’re generally riskier than plain vanilla stocks and require more skill to trade: the bid-ask spreads are higher, there’s less liquidity than with stocks, and any one stock could have a few dozen different options with different strike prices and maturities.

There are also more inputs in valuing the options: just as one example, you need to decide what measure of volatility to use, which makes the task considerably more complicated than just valuing the underlying stock.

The coolest part about options is that you can make a LOT of different types of trades.

One common example is a straddle – buying a call option and put option at the same strike price, which gives you a positive payout if the stock moves up or down past a certain amount by maturity.

Even the names themselves sound pretty creative: besides the straddle, you’ve also got the butterfly, the iron condor, and the strangle.

You can also come up with all sorts of crazy payout profiles of your own by combining options and plain vanilla equities.

Leverage is also built into options, so you can easily quadruple the money you put into one stock option: the risk management department would never let you put most of your money into a single option, but even trading smaller amounts of money gives you an adrenaline rush with options.

Even though more math is required, you still don’t need to be the next Isaac Newton to trade derivatives: being able to derive the Black-Scholes equation from Ito’s Lemma isn’t necessary.

However, you do need to understand the Greeks – how an option’s price responds to changes in time, interest rates, volatility, the underlying stock price, and more. You also have to be good with Excel because you need to make more calculations than plain vanilla equity traders.

Pros: More “interesting” and quantitative than plain vanilla equity trading; you can be more creative in devising your own trading strategies.

Cons: Again, hours are longer than agency trading; more quantitative ability is required; as you move up and become more specialized your exit opportunities also narrow.

Algorithmic Trading

No, I’m not talking about the trading robot here (please don’t fall for that scam).

Also known as algo-trading or program trading, in algorithmic trading you don’t actually trade anything yourself: you just program a computer to trade for you based on technical analysis, market volume, or even parsing news headlines.

To do this, stock analysts need to look at historical market patterns, programmers need to implement the system, and everyone else needs to use, monitor, and configure the system.

Sometimes algo-trading is 100% automatic, but it can also be combined with human trading.

Some hedge funds do 100% algo-trading and have performed well – but ever since the financial crisis and the onset of apocalypse in the markets, many previous market patterns stopped holding true.

The result: trading algorithms that had made a lot of money in the past started losing money and thousands of hedge funds and trading firms collapsed.

That’s not to say this is a “bad” field to go into: it’s just that the financial crisis made it necessary for trading algorithms to change their assumptions, and that may mean more challenges for those designing the algorithms.

When people say algo-trading, you would normally think of proprietary algo-trading – but there’s actually agency algo-trading as well, which focuses on how best to execute a client’s trades.

If you’re coming from a highly analytical or IT background, you like working with data, and you want the thrill of huge trading profits without having to stare at charts every second, this could be a good option for you.

Pros: What could be better than machines making money for you when you’re not even there? Also, this is a good option if you’re from a more technical background and you want to move into finance. Since there’s analysis and programming, you can also exit to non-finance jobs more easily.

Cons: Financial crisis will present new challenges for trading algorithms; also, a lot of the work in actually creating the algorithms and sifting through data can be rather tedious.

Exit Opportunities

Not too much is different here vs. fixed income: you either stay in trading at an investment bank, or you move to a hedge fund or prop trading firm.

Or if trading is not for you, you move to a different industry.

If you haven’t been in the field too long then it’s possible to move over to investment banking or others in your bank – but if you start out a hedge fund or prop trading firm, your mobility is more limited.

All of the above is true for the same reason it’s true of fixed income: your skill set is more specialized than, say, an investment banker’s, and on paper most of what you do doesn’t seem relevant to other fields.

Coming Up Next

Sales & Trading vs. Investment Banking and some day-in-the-life stories.

About the Author

Jerry Chi graduated from Stanford, worked in equity research and trading in Japan, and then started and sold his own prop trading firm in China. He earned his MBA from Wharton, and then worked at Google and Supercell in Japan.

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by Zeke Lee Comments (128)

On the Trading Floor

trading_floorThis article was guest-written by Zeke Lee, a Stanford graduate, former management consultant with Booz & Company, and current derivatives trader on Wall Street (Oh yeah, he’s one of my friends from school as well). He founded the GMAT Pill based on his experience scoring in the 98th percentile on the GMAT in just 2 weeks with a unique study method.

Have you ever seen a trading floor?

No, we’re not talking Liar’s Poker here…

We’ve all seen the so-called “pit traders” on CNBC yelling and screaming at each other. But what’s it like on a typical trading floor at a large bank that you might work at?

Usually, you’ll see one large open room – no cubicles. On the outskirts of the trading floor you’ll see conference rooms and occasionally the offices of the Managing Directors.

On the floor itself, you’ll see rows of really long desks that are sectioned off per person. Traders within the same group will naturally sit within close proximity of each other. So you might see the foreign exchange group in one area, the credit group in another, and the equity guys somewhere else.

But you’ll notice something unique about each trader’s desk: the monitors. No, not that they are eco-friendly and conserve energy – just that there are so many monitors on each desk and that some of them are blinking constantly.

Got Monitors?

If you’ve never worked in trading before, you might think there’s no reason you would actually need between 3 and 8 monitors – the other 7 must be for playing World of Warcraft, right?

Wrong.

Partly, it’s for showing off: some traders view the number of monitors they have as a status symbol on the trading floor. Hey, even if you can’t see my BMW, my 8 monitors mean that I own a really expensive car, right? Or at least that our P&L is higher than that of the other group over there with only 2 monitors.

The actual rationale – status symbols aside – is that speed is extremely important in trading, and you don’t want to waste time toggling between windows. Alt + Tab is for bankers.

You need to be able to look up and know that Apple surged 4% in the last 10 minutes.

Then you need to monitor the market news and major headlines coming in through Bloomberg – is some analyst raising their forecast for the number of iPhones sold? Was there an announcement that just came out regarding Apple’s contracts with AT&T and Verizon? Did consumer spending numbers just come out?

As an active prop trader, you’re multi-tasking all the time and constantly thinking about these kinds of questions, assessing risk, and making quick decisions.

Bloomberg

Bloomberg is an expensive news/finance information service that all banks and trading firms have access to.

Beyond just watching the news, you also need to track stocks you’re interested in and see their prices updated in real-time – so you use another monitor for that. These screens are constantly blinking as the prices of securities are changing every second.

Bloomberg has a price feature that lets you organize and track stocks by sector (Technology, Financials, Energy, etc.) and lets you see where everything is trading.

You can also get a real-time heat map of the market, so you can see which sub-sectors of the S&P are up, and by how much.

Trading Platform

Next, you use another monitor to actually make your trades – this might be Merrill’s MLX platform, Goldman’s REDIPlus platform, FlexTrade, Fidessa, or anything else.

If you’re trading equity derivatives, you need to enter your orders for stocks, puts, and calls quickly and monitor any pending orders that are waiting to be filled.

Why do you need an entire monitor just for making trades?

Because you might be trading over 100 individual stocks, and each of those stocks might have over 20 positions in option contracts, with various maturities and strike prices.

Depending on what you’re trading, you might actually need 2 monitors to track everything.

Option Valuations / Other Calculations

If you’re not trading derivatives, you won’t need to value options – but you may well have to make other calculations, whether you’re valuing bonds, analyzing the yield curve, or back-testing a trading strategy.

While the “math” itself is not quite rocket science, it goes beyond what most bankers deal with: simple arithmetic. While investment bankers may come from liberal arts, finance, or engineering backgrounds, derivatives traders primarily come from mathematical / engineering backgrounds.

Your firm might have a proprietary way of valuing options, developed by a senior IT programmer (see, the back office may have some merits after all) – and depending on what you’re trading, it might be very complex.

Getting these programs working properly can be difficult because they need to be synced up with other programs you use. Getting the # of shares and contracts held, exposure to risk, and other variables linked together dynamically rarely works perfectly – and this complexity means you’ll be calling the back-office tech guy or floor IT guy to fix technical issues quite frequently.

Messages

Of course, you’ll also need a monitor for Outlook – the standard email program at banks – to handle email and see incoming messages from broker and the rest of your team.

The Rest of Your Desk

So what else is on your desk?

Just like at a bank, you get a phone terminal along with a headset and regular phone – but be careful about the conversations you have, because anything between brokers and clients is recorded.

Talking about bottles may not get you fired – but you probably want to postpone talking with your model(s) until later. Even if it’s not recorded, everyone else on the desk will hear what you’re saying.

The phones are also connected to CNBC audio, so you can listen to what’s going on in the news throughout the day.

So What Else Do You Do On the Phone Besides Chatting with Models?

For one, the phone actually rings quite often – especially between the trading hours of 9:30 AM and 4:00 PM.

Most of the time, brokers call to tell you what their clients are looking to buy and sell and see if you have any interest. Some of this is shifting to online chat instead, but it’s still common for brokers to call to get your attention on larger orders.

Sometimes junior traders will screen the phone calls first before bothering the traders – you already have to multi-task a lot, and getting called every 20 seconds makes your job even tougher.

Forget About the Bathroom – or Trips to Starbucks

This also brings up another key point and a major difference between banking and trading: most traders hate leaving their desks for fear of missing out on something important.

  • Lunch breaks are limited to 15 minutes (and often the junior guys or interns will go get the food for them).
  • Bathroom breaks are rare unless you really need to go.
  • Forget about 10 trips to Starbucks during the day: bankers can do that only because they have so much down time.
  • No friendly chats with the cute marketing intern – at least not until the market is closed.

This also means that it’s common for traders to gain weight: they pretty much just sit there all day, eyes glued to the monitors, only taking the occasional break to eat.

If you walk up and try to talk to a trader, half the time he won’t even look at you: this might seem rude to you, but to him not paying attention for even a few seconds might result in a loss of thousands or tens of thousands of dollars.

And part of it is just habit: they’re so used to having their eyes glued on the screen that it’s almost weird to look away from it.

Hey, if you had that much money on the line constantly, you probably wouldn’t give the time of day to bright-eyed interns or newbie traders either…

About the Author

Zeke Lee is a Stanford graduate and former management consultant with Booz & Company and derivatives trader on Wall Street. He founded GMAT Pill, a top-rated online GMAT Prep course designed for busy working professionals who want to study less and score more.

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by Jerry Chi Comments (212)

What Do You Do In Fixed Income Besides Bankrupting Your Firm with Toxic Assets?

Stock market price ticker board in bear stock market day. Stock market board show financial crisis. Unstable nervous emotion of stock market traders sell. Bad news hit stock market. Red ticker chart.

If you’re reading this, you probably don’t know too much about what you actually do in investment banking and sales & trading beyond a lot of work, Excel, and models and bottles.

Why else would the articles on Mergers & Acquisitions, Restructuring, and UBS LA be among the most popular ones here?

We’re going to fix that today by teaching you all about Trading, what Traders actually do besides gambling and eating a lot of junk food, and specifically what you do in Fixed Income.

This was written by Jerry since he actually worked in trading before, so direct all questions/comments to him.

Types of Trading

“Trading” is a nebulous term, so let’s fix that by discussing the two basic types first: agency trading and prop (proprietary) trading.

There are far more than 2 types of trading, and there’s always overlap between these, but these are the basic categories.

Agency Trading: You simply execute orders for the client – you’re merely an “agent” doing what he/she wants and do not have (much) freedom.

Prop Trading: You are the principal and can make whatever trades you want, using your own money – within your trading mandate and risk limits.

These are the 2 extremes – no choice, and 100% choice. In between is a generic area termed flow trading where there’s some element of agency trading but also some prop trading involved.

Example: in flow trading if the client wants to buy a stock, you can be the seller – and if he wants to sell, you can be the buyer, so you’re effectively acting as the principal there.

Flow traders can also choose to reject orders and generally have more freedom than pure agency traders.

Note: There is a lot of discrepancy and overlap between all these different types of trading, and each firm is set up somewhat differently. These are just the basics.

Equities vs. Fixed Income vs. Everything Else

Flow trading and agency trading refer to whether or not you have clients. The other main category is what you trade – individual companies’ stocks? Bonds? Currencies? Derivatives of those?

There are lots of different groups within Sales & Trading at a bank, but today we’re going to focus on Fixed Income – anything that involves debt.

“Fixed” Income?

Originally, Fixed Income meant that whatever you traded had a “fixed” income stream – think bonds, loans, or anything else based on bonds or loans (derivatives). If it paid a certain interest rate and was redeemed at the end of a specified period, it was fixed income.

But once clever bankers started creating collateralized debt obligations (CDOs) and other fancy instruments that no one really understood, the term “Fixed Income” lost its meaning – all of those were placed into this category, even though nothing about them was “fixed” other than the potential to destroy the economy.

Prices of these securities are affected mostly by interest rates set by the Fed and by the credit quality of the corporate and government issuers.

FX and commodities traders work closely with those in Fixed Income and they are often classified in the same group, even though nothing about exchange rates or commodity prices is “fixed.”

Types of Fixed Income Trading

Groups are usually divided by the types of instruments you trade – whether they’re relatively “safe” government bonds, more risky corporate bonds, or even more exotic securities. Of course, occasionally traders will venture a bit out of their own turf to trade other instruments if it is allowed at their firm.

Government Bonds

This includes US government debt (notes, bills, and bonds, known as US Treasuries), Euro-denominated German debt, and yen-denominated Japanese government bonds. There are also others like inflation-protected bonds, repurchase agreements, and bond futures.

Usually you only trade the government debt of one country, and if your team is big enough you might specialize in a certain area like 5-10 year bonds.

Although government bonds are “safer” than other fixed income securities, the job itself can be stressful because these markets are constantly trading – even in off-market hours. And that means that you need to follow these markets, even when you’re out of the office.

Since there’s so much liquidity, you can take huge positions without too much trouble (unlike, say, buying 20% of a company’s stock where you would have to disclose it). Traders who bet on the US lowering interest rates in 2008 made small fortunes by betting big.

The Work Itself

You spend most of your time as a junior trader predicting changes in the shape of the risk-free interest rate curve, because that is the #1 factor that impacts government bond prices.

There’s not too much valuation work; usually you just do simple DCF calculations in Excel or on Bloomberg to get prices – it’s not like investment banking or private equity where you use many different methodologies to value companies. Your main concern is DV01, or how much you make or lose for every 1 basis point move in interest rates.

If you like macroeconomics rather than analyzing individual companies, government bond trading may be good for you.

Corporate Bonds and Credit Default Swaps

Corporate bonds are just like government bonds, except companies issue them so there’s always the chance of default – and the yield is higher to compensate for that.

If you’re working with smaller or non-US/European companies, you need to watch the news constantly to stay on top of things – but compared to government bond trading there’s less emphasis on macroeconomic happenings.

Credit Default Swaps (CDS), meanwhile, are like insurance on bonds: they’re derivatives that let you separate the risk of default from the risk of interest rates falling, so you can effectively “insure” yourself against losing your investment.

Most banks combine these two groups, since the value of corporate bonds and credit default swaps are closely related.

The Work Itself

You spend most of your time analyzing the credit profiles of different entities and weighing the bond yield against the risk of default – so you follow both company-specific and macroeconomic news.

You analyze credit profiles by looking at the financial statements of a company, the sector as a whole, and companies’ credit ratings.

Some say the work is more “interesting” than government bond trading because you’re working with different companies and because there are more trade possibilities – buying one company’s stock while shorting competitors’, for example.

These days it would be tough to get a job in this division due to the financial crisis and the sheer number of credit teams that have been laid off.

CDS may become more “standardized” on an exchange, which might improve liquidity and transparency – so opportunities there may return in a few years.

Structured Credit Trading

Of the different Fixed Income groups here, Structured Credit Trading is the most different because they don’t spend all their time checking the market and keeping up to date on the news.

Instead, they price and package complex financial products in Excel and then sell them to investors.

They don’t make trades every day, but when a trade does happen it could be for an amount of hundreds of millions or billions of dollars – compared to the other two groups above, where the size of individual trades is typically much smaller.

Although Structured Credit Trading is the most “quantitative” of entry-level Fixed Income jobs, you don’t need a Math Ph.D. or anything because you don’t actually create the tools used to price complex securities – that’s for the Ph.D.-level quants. You just need to understand the tools and how to use them to create your own products.

You don’t spend much time looking at individual companies, since most of these “financial products” involve hundreds of companies.

The Work Itself

See above. You spend a lot of time in big Excel spreadsheets figuring out how to price different securities. This is more quantitative than what you do in investment banking or private equity – in those fields, you mostly just do addition and subtraction, and sometimes multiplication or division if it’s super-advanced.

Right now it would be very difficult to actually get into Structured Credit Trading because of the financial crisis – most groups have been hit hard, just like everything else related to credit.

However, in the long-term there will still be possibilities here, so it’s something to consider if you’re still a few years away from looking for internships or jobs.

Exit Opportunities

So now you might be wondering, “Ok, so it sounds like a lot of this is repetitive and like you do a lot of grunt work as a junior trader – surely, the exit opportunities must be better, right?”

If you go into investment banking, you could go into a wide range of different fields afterward – private equity, hedge funds, venture capital, corporate development, or something completely different.

In trading, though, you only have 2 options: stay in trading (a similar “up or out” structure exists as in banking), or move to a hedge fund or prop trading firm.

That’s because the skill set you develop is so specialized – valuing companies and performing due diligence is useful in a lot of different fields, but knowing how to trade CDOs would be completely useless at a startup or venture capital firm.

Typically, as you advance you become even more specialized – so if you start out trading corporate bonds for European telecom companies, chances are you will go to a hedge fund that also trades corporate bonds for European telecom companies. You get pigeonholed very quickly as you move to the buy-side, which is one reason I chose to leave and start my own firm instead.

That’s not to say that you can’t move into other fields in finance if you start out in trading – but it is very rare to see a full-time trader move into, say, private equity or consulting following several years on the trading desk.

Up Next

Equity Trading, Day(s) in the Life of a Trader, and more…

About the Author

Jerry Chi graduated from Stanford, worked in equity research and trading in Japan, and then started and sold his own prop trading firm in China. He earned his MBA from Wharton, and then worked at Google and Supercell in Japan.

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