I'm going to college next fall and like read about trading in my spare time. I have a lot of questions about trading however, and haven't found good answers to those questions online. I know that I have plenty of time to learn this stuff, but there are few things that really confuse me about the industry. I want my basic understanding of trading to be accurate, so I'd really appreciate any help with these questions. Also, please don't tell me to "have fun" or "worry about this shit later"; I'm asking these questions because I really like finance and want to learn how trading works.
1. How has the Dodd-Frank bill changed the trading industry? How has the bill specifically impacted hedge funds, prop trading firms, and large investment banks (like the BB's)?
2. Are BB investment banks still allowed to do prop trading? If not, what do the S&T departments at the BB's do aside from agency trading (i.e. purchasing securities on behalf of a client)?
3. What are the main differences between hedge funds, prop trading firms, and trading arms of investment banks?
4. Given the nature of the 2008 crash, are there still a lot of traders who trade derivatives and structured credit products? If I can break into the trading industry, I would like to trade these products because I really enjoy math and stat.
5. What is the typical way that people get into hedge funds? Are hedge funds like private equity firms in that they mainly take people who have years of experience in the industry?
6. As a first year trader, how large will your average trades be? In other words, what is the order of magnitude for a typical trade ($500k, $1 million, $20 million)? I realize that this probably depends on what your trading and what type of firm you work for.
Thanks in advance.
There are sweeping changes, this is a pretty broad question. In the most general sense, fixed income trading has experienced a lot more scrutiny recently, which has legal teams at BBs working around the clock to ensure compliance with all the different strands of DF. A lot of this is disclosure though, and it doesn't necessarily change the day-to-day for a trader. Someone closer to each of these groups can answer better though.
"Prop trading" is a pretty ridiculous distinction. Per the Volcker Rule, banks cannot perform prop trading, but distinguishing "prop" from "non-prop" or providing financing for clients is grey area. Most BB banks have significantly curtailed or completely eliminated "prop" desks.
HFs and prop trading firms trade for their own account, whereas the trading arms for BBs are broker-dealers.
Yes, tons.
HFs generally recruit experienced hires through headhunters. Though most HFs (depending on strategy) target IB and ER analysts.
$0. First-year traders generally don't trade (this varies by desk and headcount).
Msot banks are or already ahve shut their prop trading groups. By prop i mean non client facing. Thats the difference wehre the line is drawn. However, on a client facing desk you still take proprietary risk as most desks deal with illiquid instruments and imperfect hedges. Sellside desks arent really agency execution desks, thats cash salestrading. Trading desks manage risk that results from client flow. If a client comes and asks for a price and trades, you are responsible for managing that risk as best possible. You might decide to hedge ina certain way or just leave the posuition on etc.
hedge funds generally employ specific strategies and come up with ideas that they put on. They generally trade with sellside desks of investement banks, BB trading desks offer liqudiity to clients and manage the risk they receive from taking the other isde of transaction,. Prop trading firms generally try to scalp the market in small size.
The majority of BB trading floors is derivatives.
Some run grad programs, most you network into/get ah eadhunter depending on your experience
On a BB trading desk, the majority of trades are handling client positions, so its much more reactive than that. You will ahve risk limits that are trader specific/desk/bank specific. But if you are given responsibility of a book, and a client comes in for a large trade, you cant say no because you are too junior, so its more like managing a dynamic book of risk within limits, rather than putting on all these different prop trades.
Good answers, just wanted to add one thing. Not sure how the "prop-flow" distinction is made in derivatives, but in cash products it is a very fluid line. I will almost daily put on "prop" positions with the end goal of selling the position in a week/month with a profit. Very often I will lift that bond from a broker or bid the a holder since it has value and I think we can sell it to clients at a higher price. In other words these are trades that are proactive and initiated by me, not clients. So called prop trading is a very large part of my day to day job.
Thanks for all the answers. I have a couple of follow-up questions:
The Volcker Rule, which is a part of Dodd Frank targets these divisions.
Will just cover question 4.
Agency trading is only a very small part of a BB trading floor. In this case there is no hedging becuase as you say its just executing on behalf of someone. And then you just take the comission fee for execution.
But the majority of trading is actign as a counterparty to a transaction. So a client comes in wants to do XYZ derivative, you give a price at which you are willing to trade. If you trade you hold the other side to taht trade. It is then up to you to decide how to procedd with that risk. For example if a client comes in and sells you a load of put options on a name, you have your delta risk (usually hedged as part of the transaction), vega risk, div risk, itnerest rate risk, borrow risk etc. So you slice it up and decide what risks you want to keep and what you want to get out of.
@derivstrading, I think I understand now: traders have to hedge the risk created by buying or selling securities to other clients. Do traders make commissions on deals with clients? If not, where do their profits mainly come from? I'm guessing that profits come from the instruments used to hedge, but I'm not sure.
The spread is the bread and butter of traders (non prop, and even then, a lot of prop trading isnt to make millions off a trade but merely 1 or 2 ticks). If it wasn't for commissions, banks wouldn't exist. There are commissions all the way up and down a bank chain: retail bankers pushing mortgages to people, for i-bankers involved in a new deal, for syndicate involved in an offering, for traders selling or buying a security for a client.
The instruments used to hedge, quite typically, do NOT provide any profit, lest a commission. As an example, say i'm long some Canadian govvys (CGB) and my risk profile doesn't allow me to be either x over whatever limit for an overnight position, and most likely, i need to be completely flat. I can go out and sell whatever (almost equivalent) product (i.e. BAX, Cad interest rate futures) to make sure i'm not overexposed on some funky shit happening overnight in Asia/Eu. This is my hedge, being short BAX. Very rarely would my hedge make money in itself, but it would protect me against a loss in my outright position, i.e. whatever im holding in my book.
Profits come the aforementioned spread: on my screen i have March 13 CGBs at 133.96 right now, i would quote 95/98, meaning i could sell to a client at 133.98 or buy from at 133.95, capturing the penny or so difference.
Thanks for all the responses guys. I've been reading more about trading and everything you've said is starting to make sense. One thing I'm currently confused about though is the term security. Which of these investments are considered securities: common stock; preferred stock; commodities; currency; any type of debt instrument; indices; futures, options, and other derivatives based on the aforementioned. Given the broad legal definition of security is it easier to learn which instruments aren't securities?
A security is a contract granting you some rights, such as the right to receive certain cash flows, the right to buy or sell an underlying contract, etc. You can think of a security as a piece of paper, though most securities don't exist in physical form.
In your list, for example, commodities themselves (i.e. pork bellies, etc.) obviously aren't securities. However, futures contracts on commodities are securities.
Currencies aren't securities either. Indices aren't securities(they're just numbers), though index futures are.
http://en.wikipedia.org/wiki/Security_%28finance%29
That said, a lot of finance terms are not well-defined, and different shops have different names for the same ideas. Just get the gist of things, learn math, learn how to program, then learn finance.
^ I saw that page. I found it slightly confusing because it contradicts the Investopedia definition in a few place. I wish finance terms were standardized.
Not only are terms not standardized, they're also overloaded ("alpha", "risk") or outright incorrectly used ("risk arbitrage", lol). Mastery of the jargon comes with time.
Lol, overloaded terms. Do you know programming by any chance?
yep
You may want to get "How the Trading Floor Really Works." New book written by a MIT grad. It's on my list.
^ Thanks! I skimmed the first chapter and I think I'm going to buy it. What are other books are on your list if you don't mind me asking?
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