experience. He needs tounderstand the customer he’s working with, and each firm’s biases. He alsoneeds to understand the short-term supply and demand picture of the stock.If he believes that he’s the only seller in the market, but then a multitude ofsellers materialize out of the woodwork, he has made a critical error injudgment. Finally, he needs to understand the capabilities of the salesperson,and the type of relationship the salesperson has with the customer. While thebid-ask spread is supposed to protect the trader, in extreme circumstances thisspread offers only modest protection at best. The trader needs to have goodinstincts and the ability to assimilate a lot of information to make a timelydecision on price and quantity that gives him a fighting chance.
Tracking the tradesTraders buy and sell millions of shares a day, and it’s the trading assistant’sresponsibility to insure that the P&L (profit and loss) and the positions are
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correct. P&L is tracked on a daily, monthly and yearly basis through firm’sautomated systems. Traders become particularly protective of their P&Ltowards the end of every month. Woe to the trading assistant who ignores anerror in the accounting of the trades, called a “trade break.” A trade breakoccurs when the two sides of a trade settle up on their trades at the end of theday, based on notes that the trading assistant has taken, and find that theydon’t agree on what the trade was. (Remember, the action is fast and furious,and there is a lot of trading going on constantly, not to mention yelling andother commotion.) For example, the two sides may not agree on the price orvolume of a trade.The worst kind of trade break is the “DK” or “don’t know.” This happenswhen one side of the trade goes out to the other side of the trade to settle, butthe other side does not know the trade – doesn’t acknowledge that anagreement was made. If it’s a trade with the Street that’s being DK’ed, acommon mistake is that the assistant has tried to settle with the wrong dealer.Dealer trades that aren’t picked up within a few hours should be investigatedvery promptly – if you leave it until the next day, you will very likely not beable to know the trade. Position breaks are deadly because if you have a20,000 share purchase that needs to be busted, then all of a sudden, instead ofbeing flat, your trader is now short 20,000 shares. If you put the trade in onthe wrong side, then you’re in a world of hurt, since your position will nowbe short 40,000 shares. As a trading assistant, you must make sure you stayon top of trade breaks. A good sign of trouble is the P&L. If you made$20,000 yesterday and your P&L shows you down $30,000, then there’s agood chance that one or several of your positions are incorrect.Perhaps less frightening is the possibility that you or the customer has awrong average price on the trade. To pre-empt this problem, you shouldconfirm prices with the salesperson who did the trade at the end of every day(and also do a running recap throughout the day). Don’t let differences of afew cents here and there slide. Being a penny off on a one million share tradeis a $10,000 error.
Trader TalkTrading is a lot like waging war. Traders try to protect their profits whileinflicting harm on their competitors and working with their allies (thesalespeople) to win major objectives (the client order). Like soldiers,
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traders and salespeople also have terse conversations that are lacedwith jargon. If you’re unfamiliar with this lingo, then you probablywon’t have any clue what’s going on when watching a trading desk inaction. For this reason, new analysts and associates often struggle forweeks just to get a clue. What follows is a description of some of themost widely used jargon that you’ll hear on the trading desk. This willgive you a jumpstart on your first job in the industry.“I’m going long.”When a trader is going long, this means that he’s buying shares of stockand makes money when the stock price rises. If a trader is buying a lotof stock, he may say,”I’m going long and backing up the truck.” Thismeans the trader is buying a lot of stock because it’s at a level that hethinks is favorable, and he’d like to buy as much stock as possible.“I’m going short.”When a trader goes short, this means he’s selling stock without actuallyowning it. He’ll eventually cover the position (buy the stock), at whichtime he will say that he’s flat.“How do you stand?”Salespeople will ask traders “how they stand” throughout a customertrade. For example, if the salesperson and trader have taken a customerout of 1 million shares of stock and complete the order, the salespersonmay then ask the trader “How do you stand?” to get the trader’sposition. It’s implicit that the salesperson will not pass this informationalong to the seller. Normally this is an unnecessary question, since thetrader’s position can be displayed on the internal position monitors, butsome desks disable this function for salespeople, to prevent them fromplaying stock market with the trader’s positions. (A salesperson doesnot know the nuances of the market for a stock. If, for example, heknows that the trader is long a stock, he may believe he is doing thetrader a favor by selling it, without knowing that there is a reason thetrader is keeping the inventory.) To be sure that the salesperson is notmisusing this information by passing it along to the customer, thesalesperson may add something like, “Just me asking.”“I’m flat.”The trader with no position in the stock is flat. Being flat is the bestplace to be at the end of the day. Sometimes, a suspicious salespersonthinks a trader has gone ahead and sold stock “ahead of a customer”and will ask the trader how he stands. (Getting stock sold or bought“ahead” of you means someone beats you to the trade. In this example,a salesperson may suspect that the trader sold stock through an
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electronic network before allowing a client to buy it through thesalesperson.) The most common answer to this question is “I’m flat,”which communicates that the trader hasn’t done anything unsavory.“I’m hitting the bid.”This is always a source of confusion for neophytes. The bid is the priceon the left and the ask is the price on the right. The bid is the price thatthe dealer is willing to buy at and the offer is the price that he’s willingto sell at. To “hit the bid” means you’re going to sell to the dealer athis indicated bid price. If the bid size is less than your total order size,then after the displayed quantity is filled, the bid will go down.“I’m taking the offer.”To “take the offer” or to “lift the offer” means you’re going to buy fromthe dealer at his indicated offering price. If your order size exceeds thedisplayed offering size, then after the displayed quantity is executed, thebalance of your order will cause the offering price to increase. Don’tconfuse the bid and the ask prices. If someone tells you to hit the stock(sell the stock – remember, you’ll end up taking the stock price down)and you go out and bid every dealer for stock, you’re going to have aproblem. To say that “I’m going to take the bid” or “I’m going to hitthe offer” is an improper use of trading terminology and could earn youseveral undesirable nicknames.“I plugged him.”Traders like to be tough guys. This mafia-inspired lingo refers to asituation where another trader bids you (offers to buy) some quantity ofshares and our offering dealer sells him the entire volume of what he’sbidding for (offering to buy). Normally dealers won’t sell more than theirdisplay size, but if the offering dealer happens to be making a stand inthe stock or is working a customer order, then he’s going to stand onthe offering and “plug the bidding dealer” (e.g., “He bid me for 10,000shares and I plugged him”).“I faded him.”Fading another dealer means that the bidding dealer bought all the stockthat he got hit with (bought). If a dealer has stock for sale or is tryingto get the price of the stock down, he may have to go out on the streetand hit dealers with a “good slug of stock.” Normally, if you hit a dealerwith enough stock (offer to sell a bunch of stock), the bidding dealer willbuy the minimum quantity and adjust his bid price lower (also known as“getting out of the way.”) If instead, the bidding dealer buys all thestock that was thrown at him, he is standing firm on the bid and is saidto have “faded” the other guy.
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“That guy just backed away.”Dealers are continuously posting and updating their quotes. If a dealerfails to provide a trade at his bid or offer, then he has backed away fromhis quote. Backing away is essentially false advertising in trading. If adealer shows a market and fails to honor the market, then he hasbasically sold the rest of the Street a false bill of goods. Often in fastmoving markets, dealers will accuse each other of backing away, whenin fact a customer or competitor was able to beat the dealer to the bidor offer. In this case the dealer being accused of backing away mayindicate “customer ahead” or “competitor ahead,” in order to explainwhy he is no longer honoring the market he advertised.“Give me a name.”When stocks are surging or getting crushed, it’s often because a dealeris moving the stock. If a salesperson is working an order with a trader,the salesperson will ask to know why the stock price is moving somuch. The trader may shrug his shoulders and say “someone’s hittingthe stock.” The salesperson will then ask the trader to “give him aname.” This is necessary information for the salesperson to report backto the customer. If the stock gets hit and his trader can’t make anysales, then at the very least the salesperson wants to be able to tell himwho’s crushing the stock.“I’m out there with him.”Sometimes traders are working orders for which they know that thecustomer is going to expect to have bought or sold some stock, even ifthe stock price is in motion. If the trader gets hit by another dealer (getsan offer to buy from a dealer), this is like a tripwire. The trader will barkthe selling dealer’s name to the salesperson and then growl “I’m outthere with him,” meaning that the trader will also take a whack at thestock (advertise that he wants to sell the stock). Even though hedoesn’t sell anything, at least he’ll be able to get a lower price on thestock he’s going to have to buy from the customer.“That was a fast call (or bad call or pickoff call)”A fast call is the derisive term for an account that picks off the firm’strader on a regular basis. Generally, if the account calls up when theprice is moving up (or down) quickly and tries to buy (or sell) a nuisanceof a quantity (i.e., five or ten thousand shares), the trader calls theaccount a fast call. Salespeople who have too many fast call accountstend to have poor working relationships with the firm’s traders. A fastcall is never a good call.“This knucklehead is locking the market.”
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Market makers are responsible for maintaining orderly markets. Part ofthis responsibility is to maintain a quote that does not “lock the market.”The bid price is the price at which the dealer is willing to buy stock, andthe selling price is the price at which the dealer is willing to sell stock.Dealers are in the business of making money, so it should always be thecase that the bid price is below the offering price. A locked marketlooks like this:ORCL
11.12 – 11.12
If the bid price matches the ask price, the market is locked andtheoretically a buyer or seller could transact without paying the bid-askspread (the implied cost of trading which equals the offering price minusthe bid price). Dealers are always playing games with each other, butlocking or crossing the market is unacceptable conduct, even fortraders.“This #$@$! is crossing the market.”Crossing the market is when the bid price actually exceeds the askprice. Getting back to our ORCL example, a crossed market would looksomething like this:ORCL
11.18 – 11.12
Theoretically, in this situation, a customer could hit the 18 cent bid andtake the 12 cent offer and make a riskless 6 cent profit per share.Crossing the market is normally done if the person on the bid or offerdoes not respond to repeated bids or offers – the trader crosses themarket to get the non-responsive dealer’s attention. If no warning shotshave been fired, so to speak, then crossing the market is highlyunacceptable conduct. Traders can be fined for crossing or locking themarket.“I’m real” or “I’m natural”.Traders are always playing games in the market to confuse competitorsand to try and gain access to customer orders. The way to attractbusiness is to bid or offer stock aggressively. Pizza restaurants offer“buy one get one free” offers to get new patrons in the door. Similarly,traders can bid and offer insane quantities of stock to hook into acustomer order. Typically, in response to a trader’s aggressive market,a client will call and ask what’s going on. The client may be trying tosell stock and may have been doing so at a competing firm. At thispoint, the client will want to know if the trader is “real” or not. If thetrader says that he is “real,” it means that he’s representing a customerbid. If the trader is “not real” (or says, “it’s just me”), then the trader
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is bidding around with the firm’s capital, and does not yet have theopposite side of the trade that the seller is looking for. Sellers willnormally not be excited to hit a trader’s bid, because once the traderbuys that first piece of stock everyone sees a big chunk of stock on thebid and it’s not too long before it’s a panic for the exit. A natural buyer,on the other hand, presents an opportunity for the seller to unload hisposition with minimal disruption to the stock price. There is also thepossibility that both the buyer and the seller will expand their ordersizes.“I’m working.”Orders that institutional customers leave for the trader to work over thecourse of the day are called working orders. If the client is trying to sell100,000 shares of a stock that trades 7,000 shares a day, the normalprotocol calls for the trader to execute a small portion of the order andthe client will then leave the balance of the order on the desk for thetrader to “work.” It’s important to note that working orders have to beearned. If the seller is trying to sell 1 million shares, you as the tradercan’t just hit all the bids and say, “Thanks, I’ll call you back.” The sellersees the bids disappearing and it’s very obvious to everyone whatyou’re doing. You have to make a bid on a piece of the order and if thatbid is hit, then you earn the right to work the order. More nettlesomeclients will try and micromanage the orders. Working orders can bemarket orders (where the client tells the dealer to simply execute theorders at market prices), but more often than not they’re market orderswith strict limits. For example, the seller may have the followinginstructions, “Make sales in here, but I don’t want to lose stock below$25.” Other times the seller may say, “I need to make sales, I’m in yourhands.” The second set of instructions appears to be giving morefreedom for the trader to operate, but in fact it’s a very mixed blessing.If the client says that he’s in your hands, then the nettlesome client canbe more inclined to complain about every print (execution) that youprovide. On the other hand, if the seller gives you an ultimate low limitand stock doesn’t trade, then you can turn the limit back on the seller’shead and say that a limited quantity of stock traded above $25. Ofcourse, the tape of the market activity that day better tell the samestory.Traders giving a report back to the salesperson will say something like,“You sold 25,000 shares at $11.12, and I’m working the balance inhere.”“I’m crossing 500,000 shares 24.02 – 24.08.”
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This is the moment every trader lives for. He has a customer buyer whowants to buy the stock at 24.08 and a customer seller who wants tosell the stock at 24.02, so the trader collects 6 cents on 500,000shares (and the salesperson gets his sales credits) without committinga penny of the firm’s capital. Often, if the trader is working a seller outof his last piece of stock, then buyers will appear out of the woodwork.Nobody wants to step in front of a freight train, but if the seller has beenselling persistently and is completing his order with the last trade, thenthe trader will often want to keep some shares in his own inventory, inanticipation of the stock price increasing (“doing better”) after the sellerstops leaning on the stock.“Can I get in on that print?”With large block trades, the trader needs to make sure that he doesn’tstep on anyone’s toes. Before executing the trade, the trader will tellthe salespeople what his situation is, and will give them the courtesy ofmaking calls to their customers as a heads up. If the trader is cleaningup the seller (buying the seller’s last portions of stock), then otherbuyers will call up frantically trying to get involved (i.e., trying to “getin on that print.”) If the trader is cleaning up a buyer, then other sellerswill want to get involved. This is Murphy’s law of trading. The worstsituation for the trader is if he takes a seller out of his last piece of stockand customers are demanding more stock than he has for sale, forcingthe trader to go short a stock that everyone knows has no place to gobut up.“The bonds traded away.”The opposite of winning a customer trade is to have the “bonds tradeaway” at another dealer.Often, dealers will be asked to bidcompetitively against other dealers. The buy-side seller will ask forthree bids in competition, and will sell to the highest bidder. Generallyspeaking, traders don’t like this kind of treatment from their customers,and occasionally (or frequently), the trader will “bid to miss.” Thismeans the trader goes along with the game and furnishes a seeminglyrespectable bid which he knows the seller will not hit.“I’m getting pennied”It used to be that stocks traded in eigths, sixteenths and even thirtyseconds of a dollar. If there was a sizeable bid at 1/8ths, a traderseeking to buy the stock immediately could step in front of this bid bypaying 3/16ths or ¼. With the decimalization of the market, theminimum increase or decrease in a bid or offer is now one penny. If alarge bid is indicated at 12 cents, anxious traders can now place a 13cent bid (rather than an 18 cent or 25 cent bid) which will have higher
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order priority than the 12 cent bid. The trader trying to buy stock at 12cents who loses out to a dealer buying at 13 cents will say “I just gotpennied.” If this happens all day long, he’ll probably say something like,“I’m getting pennied to death.” Trading for pennies means that thesmall investors can get better prices for his trade, but the bad news isthat this system is also subject to manipulation by specialists who can“step ahead” of a displayed customer order by improving on the existingbid or offer by one penny.The practice of a specialist stepping ahead of the customer and takingaway the customer’s trade is called “front-running.” This practice isillegal; the current investigation into specialist firm trading activitiescenters on this alleged practice.
The Power of InformationA trader is not only constantly refining his instincts, but is also constantlyseeking to recalibrate his view of the market with information from a varietyof sources. The most valuable source of information is customer order flow.Institutional traders execute huge trades for customers. Due to the size ofthese orders, they can exert significant influence on a stock’s price. Thetrader always tries to stay ahead of a large order. If he has an order in hand,then the exercise is to sell as much stock as possible – the trader should behitting every possible bid so that he will be in position to purchase more stockfrom his sellers. If the trader doesn’t have an order, but knows that the sellerwas working an order to sell shares at the current market price about a weekago, then the trader is keeping bids in front of the customer (through thesalesperson), to entice the customer to come back with more stock for sale.Dealers will often sell anonymously through floor brokers or electroniccrossing networks to camouflage their identities. There’s a lot of smoke andmirrors involved in working a customer order, so just be aware that not allthings may be as they appear. For example, skilled traders are often able tocreate the impression of a buyer in the marketplace (even as they’re quietlytrying to sell stock), in an attempt to lure another dealer into bidding thestock.Even with the information available through Bloombergs and other sources,no dealer ever has a full picture of the market. As stocks trade throughout the32
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day, different customers and dealers are getting involved in the market. Youmay be sitting on an order to sell one million shares of stock, which indicatesto you that the stock is headed lower. Then all of a sudden, bids startappearing fast and furious because your competitor has an order to buy twomillion shares. Now you’re no longer the axe in in the game (the traderleading the market), and there’s a good chance that you’ll lose your seller toyour competitor.
The Trader’s CockpitIt costs $50,000 in computers and market data screens to equip atrader. If you’ve ever visited a trading desk, you may have been dazzledby the mass of technology assembled on a trader’s desk. Each traderutilizes different information sources, but typically you’ll find thefollowing:The BloombergThe Bloomberg machine is ubiquitous on trading desks. It is aproprietary financial database that supports advanced financialanalytics. On equity desks, Bloomberg machines are nice to have butdon’t really add too much value. On fixed income desks, however, theadvanced analytics provided by Bloombergs are a necessary part ofpricing bonds. For example, the Bloomberg can quickly calculate theamount of accrued interest due on a bond trade, and can be used toperform option-adjusted spread analysis. If you are in school, especiallybusiness school, and your library has a subscription to Bloomberg, thenit’s probably a good idea to try and sign up for a training session whileyou’re at school, so that you’re familiar with some of the advancedanalytics capabilities of the platform.Phone monitorThe phone system takes a while to get used to. If you’re a salesassistant, this is actually going to be one of the first things you shouldlearn. It’s okay to accidentally hang up on accounts for the first weekor so, but if you’re still incompetent with the phone system after acouple of weeks, you’re probably not going to last long. As a tradingassistant, one of the best things you can do to add value when you haveno clue of what’s going on is to become a secretary. Pick up the phone,ask who’s calling and put the call on hold. Then, yell across the roomand tell Jerry that he’s got a call on whatever line that’s blinking. Waita few seconds and if the line is still blinking, yell louder. Do this whenthe market is opening and when the market is closing, since this is when
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traders and salespeople are the busiest and don’t have the time to pickup the phones.The phone display has multiple screens, so part of the learning curve isfiguring out which lines are more important than others. Generallyspeaking, you want to pick up the regional offices. If you havesalespeople in San Francisco calling, they’re probably calling becausethey have an order or are working an order, so don’t let that one blinkvery long. There are trading lines and sales lines. Generally the rulehere is (with the exception of picking up regional offices), traders don’tpick up the sales lines and the salespeople don’t pick up trading lines.A salesperson’s worst nightmare is a trader talking directly to hisaccounts, and a trader dreads the prospect of a salesperson buying orselling stock with no idea of what’s happening in the market. Theabsolute last priority is the dealer lights (dealers are other sell-sidetraders). If dealers are calling, it’s generally not for a good reason, sothere’s no rush to pick them up. You can be sure that they’ll repay thefavor.Execution platform or smaller broker screensBond desks have smaller green-glowing Cantor Fitzgerald brokerscreens, where market prices and size of markets are updatedcontinuously. Equity desks have a variety of execution platforms calledelectronic crossing networks (ECN): Goldman’s ECN is calledArchipelago, Spear Leads’ ECN is called REDI (Goldman recentlyacquired Spear Leads), and Bloomberg has its own trade book ECN. Thecommon equipment that you’ll find on every equity dealer’s desk is anInstinet terminal. Instinet is a unit of Reuters, and Instinet did forequities what Cantor Fitzgerald did for the bond market, whcih is allowdealers to see quotes and trade through their computers rather than overthe phone. Instinet’s screen-based equity trading system providesanonymous liquidity to customers and dealers. Instinet is the broker’sbroker – before competition from ECNs and the recent marketdownturn, it was able to generate substantial trading revenues on anagency basis.Sun workstationThe Sun workstation will normally display a number of different screenscustomized by the trader. Traders will normally have a news ticker, aninternal research notes page, a real-time tick chart of the stock indexand bond futures, a carpet of other tickers representative of a sector ofthe market that the trader cares about, other market data pages, and areal-time position monitor that updates positions, profit and loss. Thetick-chart tracks the intra-day price of a major market index, like the
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Treasury-bond futures. Most investors look at weekly, monthly oryearly price charts. Traders are looking at tick charts that update everycouple of seconds with every trade. If the tick chart isn’t working or isdelayed, this can be a major problem for the trader, since he is reactingto stale prices. As an assistant, make sure that the tick chart isupdating properly! One more word of warning: if you are a tradingassistant and happen to be sitting in a trader’s seat, do not go aheadand customize the page. There’s a reason a trader has laid out thescreen as he has. Upon his return, he will not be happy spending timereorganizing his screen because a junior trader screwed it up.
Prime BrokerageA prime broker is designated by the client to process and settle tradesthat the client executes across the Street. The prime broker alsomaintains custody of the client’s portfolio. Prime brokerage has evolvedfrom the stock loan department.Stock loan departments havetraditionally been a very attractive business. Stock loan professionalslocate the borrow on behalf of clients that are interested in shortingsecurities. The stock loan department generate revenues by chargingan appropriate rate of borrow which it passes along to the stock lendernet of the haircut that it is entitled to for its services.Prime brokerage departments are also involved in fund administration.Fund administration is basically all the accounting and record-keepingthat is anathema (but necessary) to the small-scale hedge fund operatorwho doesn’t have the scale to keep these capabilities in-house. Someof the administration services that are offered by prime brokers include:maintaining detailed trading records, generation of performanceattribution reports for tax and financial reporting purposes, calculatingnet asset value, multi-currency fund accounting and other corporateservices. Generally speaking, access to these prime brokerage servicesare provided free of charge, but in return, it is expected that the hedgefund client will direct a minimum percentage of its business towards theprime broker’s trading desks. There is no free lunch on Wall Street.Working on a prime brokerage desk doesn’t have the same thrill of atrading desk. The pace is lower, and there is a much higher degree ofclient-focus. However, this is a highly profitable business unit withinthe typical equity trading department-the business is relatively stableand requires a minimum amount of risk capital.
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The SalespeopleCHAPTER 3If you’re interested in sales, you may have skipped over the chapter ontrading. Why should I be interested in trading if I was born to sell? If so, westrongly advise that you backtrack and read the previous chapter. We’vementioned it before, but it’s worth mentioning again: sales and trading arevery tightly integrated functions. Traders would be trading with themselveswithout salespeople, and salespeople would be losing their shirts buyingmillions of shares from fast customers without traders. Good traders are alsogood salespeople, and good salespeople need to have a good idea of whattraders are thinking. Of course, no trader wants a salesperson telling himwhat the right price for a trade is, and salespeople don’t appreciate tradersramming a price down their client’s throat either, but a mutual understandingof each other’s requirements facilitates transactions and, in theory at least,should increase profitability.
Brokers No LongerBud Fox of Wall Street fame was a broker. Today, the broker title is eschewedand we have two broad categories of salespeople: