Ten years ago, traders in investment banks were able to make ‘proprietary’ bets with the bank’s own money. If they thought security A was going to rise, they could hold it until it did. Now, proprietary trading is banned and traders in banks simply exist to bring buyers and sellers of A together. Does this mean trading jobs are now a lot easier than they used to be? Not necessarily.
If you attend one of the seminars run by ex-Goldman Sachs trader-turned-trader trainer Anton Kreil, you might come away thinking that trading jobs in banks are now inherently boring. Kreil says that 80% of banks’ trading businesses are now agency based (ie. they just match up buyers and sellers directly) and that the remaining 20% of trades which involve some risk are mostly automated and undertaken by algorithms. As a result, traders in banks simply sit around monitoring what the algorithms are up to. “There is very little skill required in trading in an investment bank these days, because execution doesn’t require a human!” says Kreil.
However, other traders disagree.
David Hesketh, a former Bank of America Merrill Lynch trader who now runs Financial Skills, a company that makes software for trading simulations, says investment banks’ junior traders need to be just as skillful as before. As opposed to being pure agency traders who simply match buyers to sellers, Hesketh says banks’ traders are usually market makers. This means that they buy security A in anticipation of selling it on to clients. In doing so, traders have to take a judgement on how much of A clients will want to buy from them, and how much they’ll them for it pay for it
“When making a market, a trader will do two things,” says Hesketh. “First, the trader needs to work out the prices at which they would be happy to buy or sell the asset. Second, they need to determine the amount they are prepared to buy or sell at those prices.” Market-makers talk in terms of “bids” and “offers” (an “offer” level is also referred to as an “ask” level). A bid is the price at which the trader is prepared to buy A from the market. The offer is the price at which he is prepared to sell A to the market. When someone in the market wishes to sell something to a market-maker, they are said to “hit” the trader’s bid. When someone in the market wishes to buy something from a market-maker, they are said to “lift” the offer. If a market-maker buys from someone in the market hoping that someone else will later lift their offer, they are said to be running a “position” or “risk”.
“Traders have some discretion about when to offload a position into the market,” says Hesketh. “It doesn’t always make sense just to offload the position immediately – it takes judgement. Sometimes you have to hold the risk. It’s very rare that two clients simultaneously hit your bid and lift your offer.”
“How long will you hold A on your books? That all depends what it is exactly. “If it’s something like a highly liquid currency pair (e.g. EUR/USD), it might be seconds,” says Hesketh. “If it’s a complex security like a structured credit derivative, it may be weeks because there are fewer buyers and sellers in this market (i.e. there’s less “liquidity”)”
Matters are complicated by regulations like the Volcker Rule, which define what constitutes proprietary trading (making bets with the banks’ own money) and what constitutes market-making (facilitating the purchase and sale of assets by the bank’s clients). It’s possible that one unintended consequence of the Volcker Rule is to force traders to close their position – at a loss if necessary. “You may need to bite the bullet and just offload the position,” says Hesketh.
Will De Lucy, co-founder of Amplify Trading, which trains traders and also runs trading simulations for major banks, says that if anything, trading in an investment bank is now a higher-skilled profession than it used to be. “To succeed as a market maker, you need to have an opinion about the price and demand of the product and you also need to know a lot about how the product is traded – How liquid is it? How long will you need to hold your position for?
“As a proprietary trader you need to analyze how the price of a product is moving and why. As a market maker, you need to do that and you need to know how you’re going to unwind the trade. It’s another level of complexity,” De Lucy adds.
“It’s wrong to say that trading in banks takes no skill now,” says Hesketh. “Banks would be very interested in using robots instead of humans to trade – humans have pensions, desks, and computers – but robots can’t always take over from market makers, especially in illiquid markets.”