Those who haven’t worked in the industry may not be aware that nowadays most investment bank traders will only trade one particular sector or cross rate or country. This has not necessarily always been the case. When I first started in the industry as an 18 year old trading Japanese warrants in 1989 all the banks involved in that market divided their trading books into alphabetical order. For example, I traded all warrants whose company names were from S to Z such as Sumitomo Chemical and Toyota. While this arrangement had seemed to work during the bull market years, it was only when the market got tougher during the crash years that banks realised that it would be far better to divide the trading books by sector as there was no discernable correlation between the contracts we were trading and it was possible for example for all traders to be taken short in say steel stocks because they started with different letters and were therefore traded by different traders.
Similarly, in recent years the number of traders who are allowed to trade a variety of products has been reduced too in an effort to smooth out the performance of trading desks. Without a doubt these are among the reasons why on the whole the performance of bank trading desks has become more consistent.
Futures pit locals also stood in one pit all day and every day and now that most futures markets are screen based the majority of consistently profitable futures traders still trade one contract or spread, day in and day out. By doing this traders become better acquainted with how their markets trade and get a better idea of where opportunities are in their market as opposed to risk. There is another equally important facet to this type of trading and that is by knowing his/her market a trader is less likely to incur losses from a lack of knowledge of that product. To illustrate what I mean by this I will describe a few situations that I have personally witnessed.
When the LIFFE floor was in full flow there were a few traders who arbitraged between the prices of Bund futures on LIFFE and the DTB (now Eurex). Both contracts had similar specifications and so this style of trading had little downside. When the markets went screen based, the French Exchange listed a Gilt Futures contract to compete with LIFFE. A group of very successful Bund arbitrageurs decided to arbitrage between these contracts and couldn’t believe their luck when the French contract listed with a large price discrepancy to the LIFFE contract. They began to short one contract and buy the other but the prices did not change. Eventually a third party I believe realised what was going on and contact was made with this group of arbitrageurs to explain to them that the two contacts had completely different specifications and while their prices were different their yields were the same. I believe that each arbitrageur lost in the region of GBP 75,000 in only a few hours as a result of this lack of due diligence.
Similarly a convertible bond team at a major US bank suffered huge losses from not understanding the intricacies of a new style of preference CB and they traded them as if they were standard CBs. In both these example we are not talking about inexperienced traders but traders with great experience and who were until then highly profitable.
These are just two of many similar instances that I can recall over my career thus far which is why I am such a firm believer in the due diligence process and why I advocate to my clients to know what you trade and trade what you know. Sometimes if you trade a contract or product which you know little about the opportunity which you think you are spotting is actually not an opportunity but a mistake. I saw this particularly with some highly intelligent quantitative CB traders that I worked with who would scan for great trades only to be told by a more experienced trader that there were reasons why they looked like great trades which were usually because of some specific market nuances. They were in fact not great opportunities and the ‘cheap’ bonds they had found wee cheap for a good reason!
I remember a trader at one bank that I worked at, upon moving from the Gilt trading desk to a general proprietary desk where he could trade anything, told me that he found his new position far harder. There were so many contracts and products to choose from there seemed like there were opportunities everywhere, whereas his experience told him that many of these ‘opportunities’ were more likely to be risk. He in fact asked to go back to the Gilt desk because he felt he could make far more money just trading that one contract because he knew it so well.
While banks and bank trades now realise that they will actually make more money by specialising, private traders believe they are knowledgeable about a variety of markets and trade accordingly. Often they are encouraged by technical analysis supporters who believe that the same methods of analysis can be applied to all markets. Indeed this is one of the reasons why technical analysis is so popular among private traders because it supposedly gives them a way of analysing any market they choose. Traders often scan hundreds or thousands of stocks or contracts through their chosen system looking for the ones which seem to offer the best opportunity. However in doing this they increase the chances of trading something they know little about and therefore open up the potential for losses such as those I have described.
Some traders initially think that their opportunities will be less if they specialise in one or two sectors, but what they find is that there are still enough to make money. More importantly, their trading becomes more consistent and they start to eliminate some of the avoidable losses that dogged their trading from time to time. In fact even some technical traders have admitted to me that they seem to do better on the contracts that they know more about and acknowledge that rather than their technical skills being the reason for their profits it may well be their knowledge that is helping them.
As with all of my views and beliefs this is based solely on my experiences. When I began my trading career at the age of 18 I had not read any books or attended any seminars by traders. I have learned my trading from the profits and losses of myself and the traders that I have worked closely with. I guess this is one advantage of working on trading floors in that I have been able to watch others trade and do not have to rely on stories which may or may not be embellished. It is my feeling based on this experience that every trader would benefit from knowing what they trade and trading what they know.
Gary Norden is Director of Marketwise Trading & Consulting, a trading and education firm based in Australia. Prior to moving to Australia Gary had lived in London where he had an extensive trading career. He spent many years as an options ‘local’ market maker on LIFFE and has also managed derivative trading desks for investment banks.
Gary has taught traders at most of the institutions that he has worked at and has consulted to other investment banks and trading software firms.
Gary is also the author of Technical Analysis and the Active Trader published by McGraw-Hill which discusses the use and effectiveness of technical analysis in today's markets and explains some of Gary's own views and trading disciplines.
More information is available at www.marketwisetrader.com
Similarly, in recent years the number of traders who are allowed to trade a variety of products has been reduced too in an effort to smooth out the performance of trading desks. Without a doubt these are among the reasons why on the whole the performance of bank trading desks has become more consistent.
Futures pit locals also stood in one pit all day and every day and now that most futures markets are screen based the majority of consistently profitable futures traders still trade one contract or spread, day in and day out. By doing this traders become better acquainted with how their markets trade and get a better idea of where opportunities are in their market as opposed to risk. There is another equally important facet to this type of trading and that is by knowing his/her market a trader is less likely to incur losses from a lack of knowledge of that product. To illustrate what I mean by this I will describe a few situations that I have personally witnessed.
When the LIFFE floor was in full flow there were a few traders who arbitraged between the prices of Bund futures on LIFFE and the DTB (now Eurex). Both contracts had similar specifications and so this style of trading had little downside. When the markets went screen based, the French Exchange listed a Gilt Futures contract to compete with LIFFE. A group of very successful Bund arbitrageurs decided to arbitrage between these contracts and couldn’t believe their luck when the French contract listed with a large price discrepancy to the LIFFE contract. They began to short one contract and buy the other but the prices did not change. Eventually a third party I believe realised what was going on and contact was made with this group of arbitrageurs to explain to them that the two contacts had completely different specifications and while their prices were different their yields were the same. I believe that each arbitrageur lost in the region of GBP 75,000 in only a few hours as a result of this lack of due diligence.
Similarly a convertible bond team at a major US bank suffered huge losses from not understanding the intricacies of a new style of preference CB and they traded them as if they were standard CBs. In both these example we are not talking about inexperienced traders but traders with great experience and who were until then highly profitable.
These are just two of many similar instances that I can recall over my career thus far which is why I am such a firm believer in the due diligence process and why I advocate to my clients to know what you trade and trade what you know. Sometimes if you trade a contract or product which you know little about the opportunity which you think you are spotting is actually not an opportunity but a mistake. I saw this particularly with some highly intelligent quantitative CB traders that I worked with who would scan for great trades only to be told by a more experienced trader that there were reasons why they looked like great trades which were usually because of some specific market nuances. They were in fact not great opportunities and the ‘cheap’ bonds they had found wee cheap for a good reason!
I remember a trader at one bank that I worked at, upon moving from the Gilt trading desk to a general proprietary desk where he could trade anything, told me that he found his new position far harder. There were so many contracts and products to choose from there seemed like there were opportunities everywhere, whereas his experience told him that many of these ‘opportunities’ were more likely to be risk. He in fact asked to go back to the Gilt desk because he felt he could make far more money just trading that one contract because he knew it so well.
While banks and bank trades now realise that they will actually make more money by specialising, private traders believe they are knowledgeable about a variety of markets and trade accordingly. Often they are encouraged by technical analysis supporters who believe that the same methods of analysis can be applied to all markets. Indeed this is one of the reasons why technical analysis is so popular among private traders because it supposedly gives them a way of analysing any market they choose. Traders often scan hundreds or thousands of stocks or contracts through their chosen system looking for the ones which seem to offer the best opportunity. However in doing this they increase the chances of trading something they know little about and therefore open up the potential for losses such as those I have described.
Some traders initially think that their opportunities will be less if they specialise in one or two sectors, but what they find is that there are still enough to make money. More importantly, their trading becomes more consistent and they start to eliminate some of the avoidable losses that dogged their trading from time to time. In fact even some technical traders have admitted to me that they seem to do better on the contracts that they know more about and acknowledge that rather than their technical skills being the reason for their profits it may well be their knowledge that is helping them.
As with all of my views and beliefs this is based solely on my experiences. When I began my trading career at the age of 18 I had not read any books or attended any seminars by traders. I have learned my trading from the profits and losses of myself and the traders that I have worked closely with. I guess this is one advantage of working on trading floors in that I have been able to watch others trade and do not have to rely on stories which may or may not be embellished. It is my feeling based on this experience that every trader would benefit from knowing what they trade and trading what they know.
Gary Norden is Director of Marketwise Trading & Consulting, a trading and education firm based in Australia. Prior to moving to Australia Gary had lived in London where he had an extensive trading career. He spent many years as an options ‘local’ market maker on LIFFE and has also managed derivative trading desks for investment banks.
Gary has taught traders at most of the institutions that he has worked at and has consulted to other investment banks and trading software firms.
Gary is also the author of Technical Analysis and the Active Trader published by McGraw-Hill which discusses the use and effectiveness of technical analysis in today's markets and explains some of Gary's own views and trading disciplines.
More information is available at www.marketwisetrader.com
