Traders - would you choose a product based on liquidity?
Had an interesting discussion with another user over PM that prompted this thought.
Despite the fact that margins are low for very liquid products like cash Treasuries and spot FX, they are the ones that lend themselves most easily to the PTJ/Livermore style of speculation, precisely because of their liquidity. This user with whom I corresponded (won't say who) was seriously contemplating going into one of these areas because that was the tried-and-true path to macro funds, in spite of a) the overwhelming odds against a random spot FX trader becoming the next PTJ, and b) the lower spreads you earn on the sell-side making markets in a liquid product, should the PTJ dream not work out.
If you had no PTJ-type aspirations and were content with staying sell-side your entire career, you should ideally pick a more illiquid product (perhaps options, or EM, or structured credit), the kind that trades a couple of times a day or month, in order to earn those fatter spreads. But trading such an illiquid product essentially precludes you from becoming a PTJ/Livermore-style speculator.
I suppose the probability of success and the utility from each scenario will cause everyone to weigh the decision differently.
I'm interested to hear whether and what those of you who are now traders or fund managers thought about this issue...
How does EM trading prevent you from becoming the next PTJ? If anything, I would say it increases the odds.
Whenever I hear about the people's aspirations of being the "next PTJ", the first thing that comes to mind is "survivorship bias".
I think of the consequences of eating Fried Chicken more often than Sushi.
Do you find that eating too much fried chicken makes you bloated and less nimble, thus reducing the effectiveness of your systematic/quant macro strategy?
I picked EM as an example of a rather illiquid product that doesn't trade as often, compared to the G10 stuff. Makes it more difficult/costly to test the waters and flip your positions on a dime.
PTJ/Livermore-style trading is not similar to spot FX or cash treasuries. Those desks have a lot to do with managing your inventory and being 'forced' to take prop risk as you make markets. I doubt there are any PMs on the buyside who operate at the pace of spot FX traders. Doesn't mean macro funds can't use guys with that background, since understanding those markets is a skill.
Of course, EM credit or something like that is far more illiquid than oil or S&P futures but the time horizon is closer to what a traditional macro fund would be doing and there would be a certain element of analysis underlying most of your trades.
I'm not sure I'm expressing this quite right but the examples you picked are a little too fast-paced to really compare with bread-and-butter macro trades.
If you watch the trader video, there's one scene where PTJ buys something and then sells it again a split second later. Sort of what Livermore does by "testing" a market with a small size trade and then legging into it if it continues to go his way. I just assumed you needed liquidity for that.
I'm not too familiar with EM and certainly not with credit (if by that you mean corporate credit?) but it seems that dealer inventories of those products are way down due to the higher RWA charges. If you wanted to "test" the market with an order like Livermore describes, I imagine it would be costly to get in and out (repeatedly).
Could you elaborate a little on the analysis involved and how it could possibly be more relevant to macro than say rates or FX? What exactly are these bread and butter macro trades?
Not sure where you mean but I've only ever heard of rates/fx/commodities traders going to a Tudor/Caxton kind of shop to trade macro (though I wouldn't be surprised if these funds which are now multi-strat have little teams of traders doing esoteric stuff).
Most futures are liquid enough to do that kind of quick turnaround thing unless you are using huge size.
What I mean by the EM credit example is that spot fx and cash treasuries are markets where you will constantly be managing your inventory and making markets. The prop risk you take is forced on you in ways it never would be at a macro fund.
In something like EM credit, which is not particularly liquid, you may have more leeway in positioning your book since you won't constantly be making a market. You would still do most trades over a fair amount of time like in the Livermore examples since you don't want to distort your market. In fact, liquidity is a huge issue in Reminiscences of a Stock Operator.
Rates and FX are the most relevant to your typical macro fund, but that doesn't mean hyper-liquid products are what's closest to the experience at a macro fund. The pace is not nearly that frenetic.
Backgrounds at macro funds are as varied as you can possibly imagine but something like IR swaps (see Alan Howard) or FX options (see Jim Leitner) are probably more typical. Credit guys are also everywhere in the space. There's a PM at Caxton who ran repo funding for Goldman for years.
I think what GB is trying to say is that making a market in a very liquid product is very different from risk taking, you're not taking the positions you want and trading them. Trading products where you don't make a market is closer to portfolio management than market making. And I kind of agree with him.
Maximus - what products don't require you to make markets?!? Don't you have to quote bid/ask as long as you're on the sell-side? Haven't heard of a desk where you don't have to make markets. Even for the illiquid stuff like distressed, I've heard, traders still have to send out bid/ask prices. Do elaborate, please.
Yeah EM credit is an extreme example and I'm not saying it's preferable to fx options or IR swaps, but it's probably closer to the day-to-day at a macro fund than spot fx.
In any case, aiming for a product that's influenced by macro factors is good but liking your team is huge as well. Starting out in S&T, you are far enough from being PM that performance matters more than the specific product.
That video was made a long time ago and there is many other fund managers today who do not do things like PTJ did. Trying to find the best product to land you in a fund is a waste of time. On the prop side there is major advantages to a liquid product and likewise to an il-liquid product, just depends what you excel at. For instance il-liquid products allow great volatility at times which could be good or bad.
As a market maker I would like the product with very wide spreads but high liquidity in the IDB broker market :)
As a market taker just give me all the liquidity in the world
so you guys are saying trading the more illiquid products with bigger spreads is more profitable than trading something like cash equities or treasuries?
@bondtradercu: Yes.
liquidity is very important to macro trading, but these days much of EM is easily liquid enuff to be traded by macro types.
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