by Jerry Chi Comments (46)

Trading Psychology: How to Think Like a Trader

Trading Psychology: How to Think Like a TraderTrading – it’s all about using your brain to analyze the options and then make the best decisions, right?

You might hear that from a trader at a cocktail party when he’s trying to impress people, but most traders know that psychology plays a huge role.

Some traders would go as far as saying that psychology and emotions are 80% of the battle.

Do not overestimate your ability to be unaffected by emotion.

Real Life vs. the Trading Floor

Even if you’ve been a calm, analytical guy or gal most of your life, don’t assume that you’ll be able to stay relaxed on the trading floor.

The pressure and stress you’ll face will be far greater than anything you’ve ever experienced – especially if you’ve only been a student before.

When I first started trading, I was confident of my math and analytical skills – so I thought I could base all my trading decisions purely on analysis, unaffected by emotion.

Nothing could be further from the truth – to see why, let’s walk through the emotions of a trade.

Trading Highs and Lows

This example is actually a short series of trades that spans one trading day – but similar emotions can occur over weeks or even months.

9:30 AM: You watch as the market opens. You are looking for a good buy entry point into Microsoft [MSFT] because they are going to announce earnings shortly after the market close today, and based on your analysis you think that they’re going to beat analyst expectations and that institutional buyers will load up on the stock throughout the day.

10:30 AM: MSFT inches upward for an hour, and then takes a small dip. You think, “Great chance to buy on the dip!”  Originally you were planning to buy 20K shares, 10K for intra-day trading and 10K for holding until after the earnings announcement.

20K shares? That means even if you successfully catch a $1 stock price move, you only make a measly $20K? Better double that.

You buy 40K shares of MSFT at $28.50 (Emotion: greed), contrary to your initial plan and risk guidelines. Based on your technical analysis, you plan to take profits on half of your shares at $28.80 and cut losses at $28.20.

11:00 AM: The broader market (that is, the S&P 500 index) zooms upward based on bullish comments by one of the regional Fed governors. MSFT zooms upwards along with the broader market. $28.60.. $28.70.. $28.80.. you’ve reached your profit-taking point!

But wait! You don’t take profits yet (Emotion: greed) The rally isn’t over. $28.90..$29.00..$29.10.. sweet! This is awesome! (Emotion: elation) You’re not sure why it’s going up this far, but who cares?

You’re making money. You pat yourself on the back. Maybe you’ll buy yourself an expensive lunch to celebrate.

11:15 AM: MSFT’s rally starts to weaken.. then it starts to move sideways.  C’mon, this rally has got to have another leg up, right? (Emotion: hope)

Then MSFT starts to fall slowly… $29.00… $28.90… Well, that doesn’t mean the rally is over, right?

Your technical indicators tell you a falling trend has began, but your heart tells you that this could be just a slightly oversized downward correction and that the rally hasn’t ended yet (Emotion: denial).

11:30 AM: MSFT starts to trend down further. $28.50… $28.30… You want to bash your head against your keyboard. Why didn’t you sell earlier? Why is this dropping so much anyway?

Some %^$^*%@# hedge fund must be short-selling huge amounts to manipulate the price. It’s not fair that hedge funds are bigger than I am. (Emotions: anger, frustration).

$28.20… $28.10… you’ve hit your stop loss point but you fail to hit the sell button. After all, MSFT was having a great day. Surely the price will bounce back up eventually? (Emotion: hope)

11:45AM: $27.60…$27.50… the selling spree is not relenting. You minimize the window that shows your losses because it is too painful to watch. Why didn’t you sell earlier?

You’ve just erased everything you’ve made from weeks of trading. How are you going to ever make this money back? (Emotion: despair)

You stop caring about how much MSFT drops (Emotion: resignation). It’s already a huge loss anyway… what’s a couple more thousand matter anyway?

1:00 PM: $26.80… your technical analysis indicators show that right now may be a good buy entry point.

You know that you already have 40K shares and you can’t afford to take any more risk. But you are mad at MSFT and you want to get revenge.

Your boss is probably going to yell at your later anyway, so you might as well go all out. You double down and buy another 40K shares, bringing your total share count to 80K (Emotion: desperation).

1:30 PM: MSFT starts to nosedive. Wait, what!? MSFT dropped 20 cents in 10 seconds!? $26.20… $26.10… What is going on? What are you going to do? (Emotions: panic, fear)

You cringe as you submit a market order to sell all of your 80K shares at $26.10. Almost immediately after you sell, MSFT stops nosediving and recovers slightly.

You sold your shares at the worst possible price; if you weren’t so panicked, you could have divided your order into chunks and used limit orders and achieved better price execution. You want to cry. You are a failure. (Emotion: depression)

4:15 PM: You spend the rest of the trading day wallowing in misery without making trades. Shortly after the market close, MSFT announces blowout earnings and it shoots up to over $30.00.

You stare in disbelief… but there is nothing you can do now – if only you had followed your initial plan… (Emotions: helplessness, regret).

If You Could Do It All Over…

What would an experienced trader have done in the above situation?

Actually, even experienced traders are affected by emotion – I’ve seen a white-haired trader at a bulge bracket investment bank turning red, swearing his head off, and pounding at his keyboard – but I’ve also met a trader in his early 30’s who never once lost his cool.

So the question should be, “What should this trader have done in the ideal scenario?

In this example, the trader should have followed his own plan and rules strictly – he should have stayed within his risk limits, sold the stock when the price hit the pre-determined stop-loss level, and he should have taken his profits when the stock reached the pre-determined profit-taking level.

In short, he should have sold immediately when the stock hit $28.80 – yes, that’s “only” a profit of $12,000, but it’s way better than losing $124,000 as this trader did.

Experienced traders know when to break their own rules because they have the discipline to not break the rules too often and to keep the risk-taking from getting out of hand.

Traders without such discipline such stick to strictly to their rules to protect themselves. As the saying goes, “plan your trades, and trade your plan.”

And if all else fails, you can just get your own trading stress bracelet.

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 Jerry Chi Comments (101)

Sales & Trading vs. Investment Banking, Part 2: Lifestyle, Co-Workers, Pay & Exit Opportunities

Sales & Trading vs. Investment Banking, Part 2: Lifestyle, Co-Workers, Pay & Exit Opportunities
We wrap up our series on Sales & Trading vs. Investment Banking with this podcast, focusing on the lifestyle, your co-workers, pay, and exit opportunities.

Whereas Part 1 was all about recruiting, this one’s all about what happens when you actually get the job – and we go into subjects like pay and bonuses in both fields and what “models and bottles” means for traders.

Once again, Jerry’s the expert here so he’s the “interviewee.”

What You’ll Learn In This 50-Minute Interview

  • How you “learn” trading and why it’s completely different from learning financial modeling
  • A day in the life for both a trader and a salesperson, how much money you trade, and how you can take a bathroom break if you need to monitor the market all day
  • Whether or not trading floors resemble Liar’s Poker, how you interact with your co-workers, and what “going out” means
  • How you get paid in sales vs. trading at banks vs. prop trading firms vs. hedge funds
  • Exit opportunities and why we both left the finance industry

Listen to the interview right here:

[audio:http://podcasts-00.s3.amazonaws.com/S&T-Part-2-On-the-Job.mp3]

Training Programs & Group Assignments

  • 1:30: How the training process differs for trading, and why you might be working with Monopoly Money at first
  • 3:50: Junior traders vs. “real” traders and how you move up
  • 5:45: Picking a desk: fate vs. free will?

A Day in the Life of a Trader

  • 8:20: A day in the life of a trader – what time do you wake up, what time do you leave, and can you take any bathroom breaks?
  • 12:40: What happens when you need to take a trip to the dentist during market hours?
  • 13:25: How much money do you actually trade as a trader – banks vs. prop trading firms
  • 15:10: Average hours per day
  • 17:00: Relations with the sales force – pleasant or do they want to assassinate you?
  • 19:15: What salespeople do all day (hint: you better like the phone)

Co-Worker Interactions

  • 22:00: How much you actually talk to your fellow traders during the day, and why the hierarchy is flatter than the investment banking hierarchy
  • 24:50: How much does a trading floor resemble Boiler Room or Liar’s Poker?
  • 26:00: Models and bottles for traders. Sorry, you know we had to say it at least once…
  • 29:15: Interests outside of work? What, really?!
  • 30:30: Is sales & trading overly male-dominated? What to do if you’re female?

Exit Opportunities & Pay

  • 34:00: Sales & trading exit opportunities
  • 36:30: The bottom-line: Pay in investment banking vs. trading
  • 40:00: How to earn a $100 million bonus (only works at Citi) and how much you’ll receive as a % of your P&L
  • 41:30: Payouts at prop trading firms and hedge funds
  • 42:20: Pay structure for sales people and how much you can make in sales
  • 44:00: Bonuses in sales: the sky’s the limit, but it’s a different sky
  • 45:30: Why we both left our respective industries – investment banking and trading

Sales & Trading vs. Investment Banking Podcast Series:

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.

Use coupon code OPTION for a 10% discount, exclusive for M&I readers.

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