Tuesday, 15 September 2015

So you want to be a trader?


I often get asked, or see people asking, how they should become a trader or fund manager? The short answer is in this diagram:

Don't worry there is a bigger version of this later


.... but that probably won't make a lot of sense unless you read the rest of this post.


The four kinds of trader

 

When I speak of a "trader" I'm going to include both those who actually do the buying and selling, as well as those who make the decisions to buy and sell, since they won't always be the same person. So fund managers are 'traders' even if they have someone else to do the actual clicking of the button (or nowadays, an execution algorithim). I'm also including systematic traders who outsource both the decision making and execution to computers, but have to design and manage the system.

Broadly speaking there are four kinds of trader:

  • Proprietary ("prop") trader (someone who trades the firms capital)
  • Institutional, buy side, portfolio manager (trades other peoples money, makes the decisions or designs the system, may or not do the execution)*
  • Institutional, sell side (eg investment bank options trader, uses bank capital but not primarily a risk taker)
  • Self funded independent trader (someone who trades their own capital)

Note that the 2nd and 3rd categories are salaried traders; they get paid a salary which is normally pretty good, plus a bonus. Prop traders normally only get a percentage of profits, though there might also be low base pay in some of the better shops. Independent traders eat everything they kill; and also stump up for losses.

I feel qualified to write this as I've worked in 3 out of these 4 jobs (portfolio manager, sell side and independent), although I have never been a proprietary trader (I do know quite a few though, so I'm not writing in complete ignorance).

An important caveat: I'm mostly ignoring the distinction between discretionary and systematic trading** here, or between asset classes. However the educational background required to be a systematic fixed income options trader is clearly different from what a discretionary spot FX trader needs; so bear that in mind. 

* in the interests of clarity I'm excluding 'execution traders', who execute buy side trades but do not make decisions as to the size or sign of the total order. This is not done for any particular reason other than making the picture above close to readable, and it's a relatively niche job; I'm not suggesting execution traders aren't real traders or anything like that... some of my best friends are execution traders...

** Systematic high frequency traders normally trade prop capital; but their career path is more similar to a systematic buy side portfolio manager so this where I categorise them.


Why do you want to be a trader?

 

This is the first question to ask yourself. The answer to this will determine if trading is really for you, and also help you decide which of the four categories you should be aiming for. Typical answers include:

  • Money (financial security)
  • Prestige (impressing people of the appropriate gender and sexual orientation at cocktail parties)
  • A deep interest in the financial markets
  • A fast paced working enviroment
  • Working with intelligent and interesting people
  • An interest in an academic subject (eg maths, computing, economics, pyschology ...) and the chance to use this in real life.
  • A high degree of autonomy 
  • Being judged on results, not subjective BS
  • Short working hours (at least compared to other finance jobs, and being say a doctor or something)

You should probably think hard about your answer. Don't say "yeah I want to work with intelligent people", if the real answer is money. This isn't a job interview. Be honest with yourself.

If you say "money", then why? Is it financial security you want, or do you want to be able to buy a flashy lifestyle and thus gain "prestige". Would you be happy as the "millionaire next door", financially secure but outwardly thrifty?

http://doesyourbaghaveholes.blogspot.co.uk/2009/07/what-cars-do-wealthy-drive.html

Or do you need to be the guy or gal turning up to a school reunion in a red Ferrari?

If you fall into the latter category I highly recommend reading Affluenza if you haven't already done so.


Which type of trading is best for me?


Now I'm going to discuss each type of trader in turn, to see how they match up to the different motivations above. Note that (a) this is all my subjective opinion and (b) things vary considerably within categories - what I'm showing is an average here. So for example whether your job is academically relevant depends more on your academic interest, and the type of trading you are doing, than on if you are on the buy side or sell side. Also working hours for salaried traders are more correlated with experience - juniors tend to do more - than with category.


First though a word about money.


Money


In general traders are paid like footballers. To be more exact there is a massively skewed or if you like pyramid distribution of income for both "professions" (although top traders earn much more than the best footballers; and the mean salaried trader probably earns more than the mean professional footballer). At the top end are the likes of Wayne Rooney* (perhaps £20 million including sponsorship deals), and the likes of George Soros, Ray Dalio and Steve Cohen (£1 billion plus). Then there are lower paid premiership players (£1 million upwards) comparable to mostly buy side and a smaller number of sell side high earners, with perhaps a handful of individual and proprietary traders (tens of millions). 

* apologies for the UK football centric figures here; feel free to transpose to your own preferred sport and country

Mr Rooney, no doubt wishing he was a hedge fund manager. http://www.theguardian.com/football/blog/2014/aug/13/wayne-rooney-manchester-united-captain-louis-van-gaal-robin-van-persie

Then we gradually descend through the lower ranks of professional footballers, at the bottom of which are bottom end league 2 players on about £30,000. Somewhere in the professional leagues are the equivalent of the average buyside and sellside traders; with average proprietary traders coming in closer to the bottom (in relative ranking, if not in actual equivalent pay).

We then have the part time and amateur footballers. Note that no footballer earns a negative number, although an amateur might end up spending a couple of thousand a year on membership, kit and travel costs. In contrast the majority, and perhaps up to 90%, of independent traders lose money. Some might be getting through five or six figures a year (though one hopes this is not for very long).

Averages are meaningless with such skewed groups. A better way of summarising is to look at ranges. First I've put a normal range which I'm reasonably confident covers about two thirds of people in each group. I've also put an extreme range, which I think 98% of people fall into (with some extremes at the upper and lower end). Apologies for putting these figures in GBP, but all the readers of this blog can probably do currency coversions in their head.
  • Proprietary trader: Normal range: £20K to £100K. Extreme range: -£10K (cost of a training courses) to £2 million.
  • Portfolio manager: Normal range: £100K to £500K. Extreme range: £50K to £10 million
  • Sell side: Normal range: £75K to £300K. Extreme range: £50K to £2 million
  • Independent trader: Normal range: £-5K to 0K. Extreme range: -£50K to £500K

Notice that some parts of the profession have a wider range than others; and that the salaried traders (sell side and portfolio manager) have higher minimums.


Proprietary trading

Success in prop trading is proportional to how many screens you have. Apparently.
Source http://cn-chillies.com/


Good for: fast paced,  judged on results

Okay for: money, prestige, interest in finance, autonomy, working hours
 
Bad for: co-workers, academic relevance

Being a prop trader means it's all about your p&l. Nothing else matters. You're only job is to trade the firms money. No staying late at the office to score political points. If you're an adrenalin junkie, there's no better enviroment. If you're not then working with hyper competitive people for several hours a day might be a little draining. Also forget about using your econometrics phd. It's just like playing a computer game.

I have never been a prop trader, and wouldn't ever want to be. But I do know some poor deranged souls who are.

Portfolio manager

John Paulson. Hugely successful hedge fund manager. So good, he can trade with his back to the desk.
www.businessinsider.com

Good for: money, prestige, interest in finance, co-workers, academic relevance, judged on results

Okay for:fast paced, autonomy, working hours

Bad for: I can't think of anything. Which is why this is the most sought after kind of trading job.


Oh yes, to be a fund manager, especially at a hedge fund collecting 2 and 20 rather than long only getting a mere 0.5 and 0. The best of these jobs are very pleasant indeed, and very, very, very, well paid. There is often the chance to spend lots of time thinking interesting thoughts, and little doing boring stuff. The only people you have to answer to (unless you've made enough money) are outside investors, and annoying risk managers.

Anyone with any sense would prefer this to any other kind of trading job, which is why they are insanely hard to get.

The author's last real job was working as a hedge fund portfolio manager, specifically at a systematic CTA.


Sell side

Tom Hayes, LIBOR fixer extraordinare. Currently the most famous sell side trader in the world. But perhaps not the best role model.
www.telegraph.co.uk

Good for: money, prestige, interest in finance, fast paced

Okay for: academic relevance, co-workers, judged on results

Bad for: autonomy, working hours


This is what most people think of when they think about traders: some guy in a bank barking 'buy! sell!' down a phone whilst snorting a line of coke as an exotic go go dancer shines his shoes with their naked derriere.

Now for reality.  Nobody has used an actual phone on a trading floor since 2006; it's all done electronically or on Bloomberg IM unless you are doing some insider trading or LIBOR rigging. Also coke and go go dancers may have been de riguer on the trading floors of the 1980's but no longer.

Also being a bank trader is nowhere near as interesting as it was pre 2008. Regulation and compliance mean that proprietary risk taking (rather than just hedging customer flow) is almost absent from banks. As a result although base salaries have risen top bank traders are now very much the poorer cousins of their buy side colleagues (though minimum pay is higher, and there is less variability). Plus the hours in banks were always longer than the buy side; that at least hasn't changed.

The author spent a year and a half working as an investment bank trader, and hated every minute.


Independent

Navinder Sarao. Alleged to have caused the flash crash (complete nonsense IMHO - Free #NavSarao). Currently the most famous  independent trader in the world.
cnbc.com

Good for: autonomy, working hours, judged on results,

Okay for: interest in finance, academic relevance, fast paced (but varies)

Bad for: co-workers, prestige

Terrible for: money

The main downside of trading independently is it's the only job in this post where you can get paid a negative amount; and indeed most people who try it manage to do that. And you don't get to work with interesting and intelligent co-workers, just some bozo who sits at home all day, probably just wearing his* boxer shorts (that's you)**. And it isn't that prestigous; since anyone in the know will realise (a) you probably don't make any money and (b) you're just some bozo who sits at home all day in his boxer shorts.

* if you don't wear boxer shorts, put the name of your favorite trading clothing here
** you could of course join a trading arcade; but that just means you'll be hanging around with other bozo's, though hopefully wearing slightly more.

The upside is you can, depending on your trading style, spend very little time on actually trading and lots about thinking interesting thoughts about the financial markets (though you're going to be a little out of the loop compared to those working in the febrile atmosphere of a real trading floor). You can use your obscure phd in neural networks to predict prices if that is your wont (though be warned, it probably won't work). And you never have to take any s*** from anybody. Except your wife, asking why you don't have a proper job anymore, and if you're home all the time anyway; perhaps you could do some chores?

In the interests of full disclosure the author of this post is currently an independent trader.


The map


We're now in a position to return to the map.



The various 'trader' boxes should now make sense. Within the buyside and sellside I've included additional boxes for the front and back office. I've also broken out 'unprofitable' prop and independent traders; these are a stop on the journey rather than the final destination.

The lines on the map show possible routes between boxes. Very thick lines are routes that are straightforward and heavily travelled; thinner lines less so (though this is all relative). So for example it's very easy to become an unprofitable independent trader; but very hard to go from independent trader to fund manager.

If a line isn't there it means I think it highly improbable that those trajectories will happen, though of course they are not impossible.

The lines are also coloured. Each colour represents a different route through the trading "profession", which I'll discuss next.

This is clearly a simplification; and I'll talk through some of the missing nuances below.

The main routes


Lone ranger (red)

It's very easy to become an independent trader. You just need some money and a brokerage account. A few clicks later and hey presto! You're a trader.

It's much, much harder for someone who is self taught, with no relevant experience and probably low starting capital, to become a profitable independent trader; one whom can give up all other work and live comfortably on the net profits from their business; with enough capital in reserve to smooth over the inevitable bad months and years that even brilliant traders will have.

A successful independent trader might want to become  a prop trader, and leverage their skills off a larger capital base. However the business model of most prop shops assumes that you trade pretty frequently to provide flow to brokers for hich the shop receives a kickback. It's very hard to be profitable if you trade a lot independently; surviving independents are most likely to be too slow to interest prop shops.

Even harder is for an independent to launch their own hedge fund. Despite this I often see people saying "I have traded for 6 months and made money, how do I start my own hedge fund". There are some new iniatives that might make this easier like http://www.fundseeder.com/ (no connection, but run by very reputable people unlike a lot of other similar firms). But be warned this route is the one with the lowest chance of success.

Prop bandit (yellow)


It's just as easy to become a prop trader. All you need is some money, which you usually have to hand over to the prop shop for 'training'. There are some more reputable shops which don't require this up front payment, but obviously they are more selective with who they pick.

Not everyone who gets in to the training course will subsequently be chosen to trade the firms capital; and only a proportion of those will last for long enough to make a reasonable steady income.

A good prop trader can probably go independent quite easily; although if they are intraday traders they may need to stay within the fold of a prop shop to keep access to the low commission rates needed to succeed in this arena.

It's slightly easier for a good prop trader to become a fund manager than it is for an independent trader; larger amounts of capital and more trading equate to a verifiable track record. Nevertheless again this is a route which has a low probability of success.



Backroom boy (blue and green)


With many apologies to female wannabe traders, but the alliteration here is too good to miss. In the olden days it was relatively common for people to begin in the mail room (this guy didn't even start there, the mail room was a promotion for him) and work their way up to CEO. Exchange floor traders would frequently start as clerks and runners.

Sidney Weinberg, telling everyone for the like the millionth time that he started as a janitors assistant, and how young people today don't even know they are born.... https://en.wikipedia.org/wiki/Sidney_Weinberg


A modern day version of this parable is to begin in a back office role (or middle office), work hard, impress the right people and hoist yourself up to a front office role. This is do-able, but not easy. You're also going to be a few years behind the cohort who start out in the front office.

You'll also need the right qualifications; if you don't start without them you'll need to go back to school to get them. The reason this strategy makes sense is that it's easier to get a back office role than to go straight into the front office. It is however still a gamble and not a path that many people travel. If you can get straight into the front office (next route I discuss) you clearly should.

There isn't much difference between the buy and sell side; except in general it's harder to get into the buy side from scratch. You can also make a parallel move from sell side to buy side; with the reverse move being slightly easier.


Fronting up (cyan and yellow)

This is probably the most common route into trading; and hence probably the most straightforward.

If you have the right qualifications, land a few good internships, and impress at an interview; then you can go straight into the front office. From here the trading desk is much, much closer. Of course there are fine variations within the front office; some front office jobs are more relevant than others, and the journey to the trading desk will be easier depending on your starting point and the kind of trading you wish to do.

Economists and strategists will fit neatly into global macro type roles, equity (bond) analysts will obviously find it easy to move to equity (bond) trading, whereas quant analysts are a more natural fit for options trading and systematic trading. Good technologists with the right experience can also move into systematic portfolio management roles. Moving from risk management into trading is harder, but I know of people that have moved between those two roles comfortably*.

* If I ruled the world all traders would have to work as junior risk analysts for 2 years before buying a single thing. And all senior risk managers would have to have at least 5 years trading experience.

If you're in an M&A or sales role then it's harder to see how a move into trading would make sense, but then these are worlds I know almost nothing about so I can't really comment.

Again it's harder to get into the buy side, and you can move from sell to buy side; with the reverse move being slightly easier.


Overachiever (dark blue and purple)


A very small number of people will go straight on to jobs on a sell side trading desk (although initially it's likely to be very junior, with relatively small budgets). An even smaller number of people do the same on the buy side.

Clearly this is the dream ticket, but you shouldn't pin your hopes on it. It really is very difficult. You should have a plan B in case this doesn't work out, like another front office job.

You can move from sell to buy side; with the reverse move being slightly easier, yeah yeah you know this by now...

There are some lines that might seem odd on the graph; from sell side trader and portfolio manager back up to independent trader. Well it's pretty simple; these are very well paid jobs. Which means trading independently is possible; and you're probably going to have the skills to do it pretty well (although the move is slightly harder for sell side traders who may find their trading strategies don't work so well when not embedded within the customer flow of a banks market making).


Final advice


If you really want to be a trader the easiest route is as follows:

  • Go to a really good university and get good qualifications
  • Get a sell side front office role that will put you near the relevant trading desk
  • Move to the relevant sell side trading desk.
  • If desired a move over to buy side portfolio management can follow
  • At this point if you're any good and you don't blow your bank account on frivolous pursuits you'll end up with enough money to trade independently, or spend the rest of your life at the beach if that is your thing.

Finally, if you're curious, and in the interests of full disclosure, below is the route I took:*


* I had a 2.5 year break from finance when moving from the sell side, to buy side fund manager...

Make of that, what you will.

Best of luck to you all in whatever career you decide to pursue.


9 comments:

  1. Where do you place commodity traders from physical houses in this categorisation ? Sell side ? They are trading customer flow but actually taking quite big risks.

    ReplyDelete
    Replies
    1. So they're more like sell side traders used to be then. Probably closer to sell side than buy side. I think the key is that a sell side trader wouldn't be profitable without their customer flow.

      Delete
  2. Just curious where you feel the quant prop/market making and hft firms fit into this map - as far as I can tell they're different to your definition of "prop" as they're usually generously salaried but they don't fit into the buy side of the chart either.

    ReplyDelete
    Replies
    1. I guess they would be similar to buy side; if you look at the skills required they are similar to those a systematic hedge fund manager would have on the buy side.

      Delete
  3. Hi Robert,

    After reading this article I'm a bit discouraged to reach my goal to become a - let's say - "hobby-trader".

    First some things about myself :
    I very much like programming and I think I have some qualities which are important to reach my goal to become a hobby trader (not greedy / some perfectionsm / very clear thoughts of type of trader : clearly systematic / patient / executing without meddling when I trust or give my promise to something).
    Your book is for me a very important step in my process because it give a lot of interesting ideas to build up a trading framework. The strategies will come later in my opinion.
    It's certainly not my goal to quit my day-job because I don't want to lose my financial security. On the other hand, I don't want to loose my entrire trading capital, then it will be a very expensive "hobby". Of course I know that there could be substantial drawdowns, but that's part of the game. My goal is to earn little bit of money out of my trading (let's say 5+ %/year after costs).

    Now my question :
    It's not clear to me what you mean by 'very hard'. Will it mean one must change his attitude (natural habits), create and write your own trading framework, stick with your plan and such things ?
    Or is it because a new independent trader has not enough 'financial knowledge' ?

    Maybe my question is a little strange but your opinion is useful for me (and maybe other people)

    ReplyDelete
    Replies
    1. It's more the former. The problem most people have is sticking to a plan. To run a basic systematic strategy isn't something that requires a vast amount of financial knowledge.

      Delete
    2. Thanks Rob, this gives me a better feeling and confirms that I'm on the right track. I'm absolutely prepared to learn basic things about financial instruments but don't want to be a financial or an econimic 'expert'.

      Going further to develop my framework.

      Delete
  4. Hello Rob,
    This *might* be the most relevant blog post to ask this question, here goes:

    From your experience as both an institutional trader and independent, do you think that being aware of prices/flows in the swaps markets (rates, volatility, correlation, etc) are of any use to a futures trader when trying to make more-informed decisions as to broad market sentiment? I can't help but wonder if there's a higher signal-to-noise ratio in the more liquid swaps, and that they might represent 'upstream' information. Then again, access to timely swaps market data might be tricky for a retail schlub such as I.

    ReplyDelete
    Replies
    1. Tricky question. The problem is that only institutional traders have access to the swaps market. They will also have access to other information, and on average be more highly skilled (or at least make fewer mistakes). It's difficult to separate out the advantage they have into these different components.

      Broadly speaking I would say there isn't much advantage in having access to swaps data, because swaps positions are hedged first in the more liquid futures markets there is an almost perfect symmetry in the available information.

      Delete