UK
Rumours are all over the street about huge proprietary trading losses at most of the big houses in the fourth quarter and a quick glance at the results of Goldman and Morgan Stanley shows that VaR remains high by historical standards.
The first response to this is simply: Aarrrrrrrrrrrgh! What is senior management thinking? I’d guess two things – and both are flawed beyond comprehension.
The first is that prop is always a quick way to build the P&L (assuming, of course, that it pays off). Given the horrors of the past year, outsized returns towards year-end would be much appreciated. And given that bonuses are already likely to be negligible, the immediate downside from any losses will be minimal.
The second rationale, and one that’s equally disturbing, is the view that this is too good an opportunity to miss. This argument goes that valuations and relative values are so incredibly skewed compared to historical norms that there are huge amounts of money to be made in the market right now.
For example, convertible bonds are trading well below their bond floors, equity correlations are at incredible highs, and a fundamental valuation of almost any asset will suggest it’s exceptionally cheap. All of these speak, in normal times, to great trading opportunities.
These, however, are not normal times and traders need to appreciate that. Trades may be directionally correct, but market irrationality outlasts people’s ability to bear mark to market losses.
Banks should know better. The market is so far removed from standard conditions that we can pretty much throw out every trading strategy for now. Risk remains unprecedentedly high, and worryingly no-one really understands it.
Therefore, the only strategy that works without luck in this environment is to be highly conservative and minimize risk. Having tried and lost, the banks have no choice now but to curtail their prop trading activities across all asset classes – and not just in those that we already knew were toxic markets. Prop traders should really be history.
They still exist because that rare breed, good traders, actually do exists! The ones who just bought when the market was bounding upwards have gone.
Agree with Dave – I’m an equity prop trader, and have made a 46% return this year – short Lehman, short WaMu, short Wachovia, short UK homebuilders, et al, offset slightly by some worse decisions! Just because some people are idiots and messed up doesn’t mean the rest of us aren’t smart cookies. I’ll be getting a materially larger bonus this year than last and deserve every penny! Happy Xmas!!
Johan..sounds like you are one smart cookie !!!! guess you work in a trading arcade or something similar if i was a recruiting manager ..i’d sure want you in my Bank..reckon you cud make me some real money
Johan, congrats on making some money with such a complex strategy – my mom could have have had a similar performance. So you short a few financials and you’re a “smart cookie”. What a load of gubbins. It’s simple, if anyone in life is making huge returns in a short space of time it because they are taking huge risks. It’s a gambling; plain and simple.
RB, you think your mum could have made 46% return when no European hedge fund manager achieved that? If what I did was so simple, then why did nobody else think of it? With hindsight it looks easy peasy and obvious, but there were so few people who shorted the financials at the right time, the MAJORITY of people have lost money this year. This is not mindless gambling, it is based on insight and foresight. I don’t care about anyone’s jealousy here, bottom line is there’ll be a hefty 6 figures net in my bank account in January, and I deserve every penny of it :o)
Actually, VaR is high because vol is sky high. You need to cut down positions very substantially to even have a VaR comparable to normal times.
prop trading is gambling!! I have no idea why shareholders dont pursue senior mgmt to shut the whole prop ops down. Prop traders are useless elements of society. If they really had the **** why dont they go out and start a business, build a product, market it and create wealth and jobs. We all know its a lot easier to sit in front of the computer and speculate. And being paid for it is even better. Bank shareholders and hedge fund investors have learnt the hard way that paying people to gamble is a one-way road to a small fortune:)
Johan – if you’re so hot. How come you’ve been checking efinancialcareers every two hours (prob more) instead of making even more money – what a duffer
Johan, Is your bonus in cash or in stock ?
Johan, anstall mig!!
Johan stop taking the p*** take your bonus and go to Barbados forever. I had enough with LOSERS like you who think they are smart cause they made some money, the first think to realise if you have any sense is that LUCK is a big factor and even much bigger under current conditions(and yes also good insight etc), you can say all this in your bank to get higher bonus/promotions etc but not here, and you are not the only to make money , I ve made 80% return on my personal account in three months by shorting GOLDMAN, but I was lucky(and worked hard and had my own models etc) but I am not trying to fool anyone that I am genious etc, with this vol you can make or lose big time
Johan, well played my son. It all does appear obvious with the benefit of hindsight but I agree it really wasn’t the case. I think that basically simple systems always work best. I.e. be long equities when the 200-day moving average is moving up and vice-versa. I also use the new/high low stock ratio which says when sentiment has turned (new highs/lows are supposed to be the best indicator of future market direction). These together along with fundamental analysis should ensure positive returns and being able to change approach to the market at the right time. For example, when teh 200-day moving average turned down in late 2007 for the first time in about 4 years surely a rational trader/investor would have liquidated all equity market long positions??? History says you should do it as a rational cause of action but people just can’t change direction for some reason. Would be interested in what approach you use?? I write a column on New highs/lows at http://www.proactiveinvestors.co.uk would be interested in getting in touch to hear what made you go from long to short…. thanks…. sign with name: Market follower (i.e. don’t use my real name which is on efinancial)
Johann all I can say is Fanita mate!!!!
Johan, your results are totally meaningless, as any well informed investment manager will know. I for one, would not be interested to hire a loose cannon like you. The best prop traders are humble, because they know very well that danger lies just around the corner. You made a good call. So what. Everyone makes a good call from time to time. This has nothing to do with being smart. What matters is how much risk you took, what your drawdowns are, what your profit factor is, your profit/loss ratio, your Sharpe ratio, your Sortino ratio, your profit to drawdown ratio, your percentage wins, etc. And this, over more than 3 years trading. Nassim Taleb would simply call you the lucky fool. Perhaps read his book “fooled by randomness”, you are the classic example of a lucky fool.
johan, will you marry me?
Why do prop desks still exist? Well, I would think the obvious answer is that many prop desks manage their risk very well and provide consistent profits, it is the highly visible minority that have made huge losses in credit. Thats why.
And for any bank to shut down profitable businesses, especially with other areas of fhe economy, and hence revenue, contracting, would be sheer stupidity.
Of course that doesn’t mean that the same senior management that failed to make rational and intelligent decisions about subprime++ will not make more stupid and irrational decisions and shut down these desks in their panicked rush to appease the public and government clamour for blood. And it doesn’t mean that beneficiaries of tax payer loans to troubled banks won’t cut off their noses to spite their faces by shutting down these profitable desks.
But many prop trading desks are run by sensible and honest and intelligent people and make consistent profits that benefit shareholders and at least some bank’s senior management have or will recognise this and will keep these businesses open.
Alphahunter, you’re a fool – just because I only gave my YTD % return doesn’t mean my other metrics aren’t good, does it? 72% win ratio (and that’s hedged against the index), 5.1 sharpe ratio, 2.2 gain:loss ratio, etc etc. And considerably outperformed the market for all 4 years I’ve been doing this. But % return and resultant profit is the most paramount metric when it comes to my bonus, the most important thing in the world.
The writer of this article seems to have very little appreciation of the position of prop traders in markets.
In most large markets traders account for a small percentage of daily volume (5-10%) the remaining percentage is the large pension funds etc.
Traders sit on top of this and exploit market inefficiencies making money for the banks that let them take risk. Ignoring long term growth this game is zero sum. In normal market conditions the traders cream off money from the whole market – the traders can, on net, make money and the funds/individuals lose relative to the general market growth – but they were only really interested in the market growth anyway.
Prop traders exist to exploit inefficiencies in the market, in doing so making the markets efficient. The fewer there are the more inefficiencies there will be and the more profitable they will become.
The current turbulence has created huge inefficiencies in all markets as very few people understand what is happening and the old methods don’t work. In the mean time prop desk will take losses, as banks de-risk, but this will only create more opportunities for future prop desks
Let’s get it right .
Bank traders always SUCK. Hedge , CTAs always beat them.
I know I could whack any bank trader given eual market access.
Johan, it’s self deluded, ego inflated and misleading idiot traders like you who give all prop traders a bad name. Now all of a sudden you come up with some stats, after confronting you with them. You should have boasted about these first then if you want to impress an investment manager. You say you have made a six figure bonus but you are wasting your time here trying to convince anyone how “smart” and good you are?? Doesn’t really make sense does it. The more you say, the more proof we get you are just a frustrated, self deluded LOSER with nothing but hot air.
Rokko is right. In the vast majority, bank traders ONLY make money off other people’s market flow, ideas and trade execution by knicking some spread, go with the flow and getting better market access. Their performance ratio’s are not monitored properly whilst they often sit on a franchise or edge of their very employer. They would not last 2 months in a proper CTA or a hedge fund where financial ratio’s and consistency are all that matter. Dreamers and boasters needn’t apply.
All these guys trying to defend prop guys are fools. Anyone who has been on a trading desk would know the truth. To say that u exploit market discrepancy is a story which works well when told to your grandmother.
Summer Intern – you are a fool! The person who sees the market flows is NOT the prop trader but the market maker. At least not in an honest set-up. And yes the market maker does make money off the flows but hey guess who gets screwed when liquidity dries up and market moves one way.
All in all, Prop trading is not a viable business model (in the long run) for a publicly traded organization. No wonder shareholders of banks have had cumulative negative returns over last 5, 10 and 15 years. The quicker we get rid of these big-talking morons, the better it is for the industry.
Alphahunter, know your audience – the vast majority of people reading/posting would not know what a 6 figure bonus was if it smacked them in the face and wouldn’t know what a sharpe ratio even is.
Having read through the comments section, my first thoughts would allude to the fact that nobody on this website can prove who they are or their credentials, and that any opinion here needs to be more of an overview rather than personal performance.
The fact remains that prop desks across the city have recorded further losses this quarter. The question of whether prop trading activities should continue, discontinue or shrink in size is the really the purpose of this article. People rattling off about how (supposedly) great they are are should realise that they are not contributing to the debate.
Personally, I know a large number of prop traders who have lost their jobs, and others who are still unsure about what 2009 will hold for them. In the process of cost cutting, I would be of the opinion that Banks need to cut cost and risk through either upgrading or getting rid of under-performers. Prop traders provide a very important source of revenue diversification, and the most talented traders in the market should be kept on board for this reason. The Banks, finally, will need to be honest with themselves and understand the enormity of the challenge they face.
At last, someone who understands what a so called bank prop trader actually does.
They’ve ridden their BS advantages for so long until now that it , when they all got caught the mother of all OTC blowups. Without their invisible , unaccountable market they are right royally buggered and rightly so.
Long live the real kings of trading – the Market Wizards !
ATL: you’re being one-sided: some prop desks are down, others are up. I agree that more are down than up – the majority of hedgies and prop traders are actually trading beta: these are the less-skilled and they’ve lost in line with momentum. But some are trading alpha: these are still making good money. This, incidentally, is also the substance of Johan’s original point.
Job losses currently, though, are overwhelmingly tied to their employer’s evaporation of proprietary capital, rather than to trading losses. With MTM compressing tradeable capital, prop.trading simply can’t occur at the same volume. no VAR = no trades. Sometimes this leads to binning traders or even the desk, sometimes it leads to the traders moving back into flow. The hedgies are having the same trouble – losing AUM ~equates to losing VAR. Only, most funds don’t have a flow…
Turning to the actual topic of the article, if I may:
Personally, I believe prop.trading always makes sense where a firm has (a) inactive capital after full (cross-cycle) adequacy provisioning, and (b) skilled non-flow-mindset traders. Otherwise you have unnecessarily fallow assets.
But the emphases there are on _full_ adequacy, and on _skilled_. Most shops model risk naively (Exhibit One: “the Credit Crunch”). And too many shops mistake self-belief or aggression for knowledge or ability.
Bit like about half the commenters on this thread, actually…
DD: I think you have misinterpreted what I was saying. I am in support of prop desks, but my point is that like the rest of the market, unfortunately these desks need to be stripped down to it’s bare bones, and a certain amount of hiring, firing or re-shuffling will need to be played out as part of an overall strategy. Taking account of alpha generation, in my opinion, this is where there needs to be a greater degree of reshuffling and dilution. Get the under performers out, or move them into another part of the bank, and keep the traders who have generated consistent alpha. Up the ante on the risk management side, and lower the assets managed per trader, in the short term. With the banks haemorrhaging money, I don’t think it’s a bad idea to allow traders to take risks, but the amount of money they play with should be lowered. If a given strategy seems to be beating the market, then increase the money these guys are playing with. It just makes no sense to stick with the status quo, and neither does it make sense to rid banks of prop desk like our author George Trower argues.
I’d be interested in what others have to say, and getting some interesting ideas in the open.
I am with DD on this. Prop trading has a role, but is being done badly and given a bad name in some places. Its all about experience of extreme market events, how to take positions off as well as put them on, and how to manage position size. If a market gets jittery, reducing position size is a good idea. Sounds sensible, but the opposite was happening at the end of 2007. Its madness that when the market started wobbling in 2007, some banks actually increased prop risk limits to buy up real estate which was trading “cheap”!
Another problem is modelling. The distribution of returns of prop arb strategies inevitably appeal to banks, as they typically have positive returns. But, the extreme negative tail events which come along literally wipe everything out, if managed badly. Its like assessing the risk of a nuclear reactor exploding. Rare, but catastrophic. Current modelling of the extreme tail events is not good enough to be punting like this.