However, salespeople and traders work much more reasonable hours than research analysts or corporate finance bankers. Rarely does a salesperson or trader venture into the office on a Saturday or Sunday, making the trading floor completely void of life on weekends.
Here's a quick example of how a salesperson and a trader interact on an emerging market bond trade.
SALESPERSON: Receives a call from a buy-side firm. The buy-side firm wishes to sell $10 million of a particular Mexican Par government-issued bond (denominated in U.S. dollars). The emerging markets bond salesperson, seated next to the emerging markets traders, stands up in his chair and yells to the relevant trader, "Give me a bid on $10 million Mex Par, six and a quarter, nineteens."
Translation: Give me a bid where you are willing to buy $10 million par value of Mexican Par Brady Bonds that pay a coupon of 6.25 percent and that mature in the year 2019.
TRADER: "I got 'em at 73 and an eighth."
Translation: I am willing to buy them at a price of $73,125 per $100 of face value. As mentioned, the $10 million represents amount of par value the client wanted to sell, meaning the trader will buy the bonds, paying 73.125% of $10 million plus accrued interest (to factor in interest earned between interest payments).
SALESPERSON: "Can't you do any better than that?"
Translation: Please buy them at a higher price, as I will get a higher commission.
TRADER: "That's the best I can do. The market is falling right now. You want to sell?"
SALESPERSON: "Done. $10 million."
S&T: A Symbiotic Relationship?
Institutional sales and trading are highly dependent on one another. The propaganda that you read in glossary firm brochures portrays those in sales and trading as a shiny, happy integrated team environment of professionals working for the client's interests. While often that is true, salespeople and traders frequently clash, disagree, and bicker.
Simply put, salespeople provide the clients for traders, and traders provide the products for sales. Trader- would have nobody to trade for without sales, but sales would have nothing to sell without traders. Understanding how a trader makes money and how a salesperson makes money should explain how conflicts can arise.
Traders make money by selling high and buying low (this difference is called the "spread"). They are buying stocks or bonds for clients, and these clients filter in through sales. A trader faced with a buy order for a buy-side firm could care less about the performance of the securities once they are sold. He or she just cares about making the spread. In a sell trade, this means selling at the highest price possible. In a buy trade, this means buying at the lowest price possible.
The salesperson, however, has a different incentive. The total return on the trade often determines the money a salesperson makes, so he wants the trader to sell at a low price. This of course leads to many interesting situations, and at the extreme, salespeople and traders who eye one another suspiciously.
The personalities
Salespeople possess remarkable communication skills, including outgoing personalities and a smoothness not often seen in traders. Traders sometimes call them "bullshit artists" while salespeople counter by calling traders "quant guys with no personality." Traders are tough, quick, and often consider themselves smarter than salespeople. The salespeople probably know better how to have fun, but the traders win the prize for mental sharpness and the ability to handle stress.
Section One: Trading - The Basics
Trading can make or break an investment bank. Without traders to execute buy and sell transactions, no public deal would get done, no liquidity would exist for securities, and no commissions or spreads would accrue to the hank. Traders carry a "book" accounting for the daily revenue that they generate for the firm - down to the dollar.
In this section, we will first distinguish between floor brokers and traders, and then cover how a trader makes money for themselves and the bank, how they hold inventory, and why trades are made.
Liquidity is the ability to find trade-able securities in the market. When a large number of buyers and sellers co-exist in the market, a stock or bond is said to be highly liquid. Let's take a look at the liquidity of various types of securities.
Common Stock: For stock, liquidity depends on the stock's "float" in the market. Float is the number of shares available for trade in the market (not the total number of shares, which may include unregistered stock) times the stock price. Usually over time, as a company grows and issues more stock, its float and liquidity increase.
Debt: Debt, or bonds, is another story however. For debt issues, corporate bonds typically have the most liquidity immediately following the placement of the bonds. After a few months, most bonds trade infrequently, ending up in a few big money manager's portfolios for good. If buyers and sellers want to trade corporate debt, the lack of liquidity will mean that buyers will be forced to pay a "liquidity premium," or sellers will be forced to accept a "liquidity discount."
Government Issues: Government bonds are yet another story. Muni's, treasuries, agencies, and other government bonds form an active market with better liquidity than corporate bonds enjoy. In fact, the largest single traded security in the world is the 30-year U.S. Government bond (known as the Long Bond).
Floor Brokers vs. Traders
Often when people talk about traders, they imagine frenzied men and women on the floor of a major stock exchange waving a ticket, trying to buy stock. The NYSE is the classic example of a stock exchange bustling with activity as stocks and bonds are traded and auctioned back and forth by floor traders. In fact, these "traders" are really floor brokers, who follow through with the execution of a stock or bond transaction. Floor brokers receive their orders from actual traders working for investment banks.
As opposed to floor brokers, traders work at the offices of brokerage firms, handling orders via phone from salespeople and investors. Traders either call in orders to floor brokers on the exchange floor or sell stock they actually own in inventory, through a computerized system called an over-the-counter (OTC) system. Floor brokers represent buyers and sellers and gather near a trading post on the exchange floor to literally place buy and sell orders on behalf of their clients. On the floor of the NYSE, these mini-auctions are handled by a specialist, whose job is to ensure the efficiency and fairness of the trades taking place.
How the Trader Makes Money
Understanding how traders make money is simple. Traders buy stocks and bonds at a low price, then sc I them for a slightly higher price. This difference is called the bid-ask spread, or, simply, the spread.
Spreads vary depending on the security sold. Generally speaking, the more liquidity a stock or bond has, the narrower the spread. Government bonds, the most liquid of all securities, typically trade at spreads of mere 1/128th of a dollar. That is, a $100 trade nets only 78 cents for the trader. However, government bonds called ‘Govies’ (for short) trade in huge volumes. So, a $100 million govie trade nets $781,250 to the investment bank - not a bad trade.
Inventory
While the concept of how a trader makes money (the bid-ask spread) is eminently simple, actually executing this strategy is a different story. Traders are subject to market movements - bond and stock prices fluctuate constantly. Because the trader's ultimate responsibility is simply to buy low and sell high, this means anticipating and reacting appropriately to dynamic market conditions that often catch even the most experienced people off guard.
A trader who has bought securities but has not sold them is said to be "carrying inventory."
Suppose, for instance, that a trader purchased stock at $527/8, the market bid price, from a money manager selling his stock. The ask was $53 when the trade was executed. Now the trader looks to unload the stock. The trader has committed the firm's money to purchase stock, and therefore has what is called "price momentum risk." What happens if the stock price falls before she can unload at the current ask price of $53? Obviously, the trader and the firm lose money. Because of this risk, traders attempt to ensure that the bid-ask spread has enough cushion so that when a stock falls, they do not lose money.
The problem with carrying inventory is that security prices can move dramatically. A company announcing bad news may cause such a rush of sell orders that the price may drop significantly. Remember, every trade has two sides, a buyer and a seller. If the price of a stock or bond is falling, the only buyers in the market may be the traders making a market in that security (as opposed to individual investors). These market makers have to judge by instinct and market savvy where to offer to buy the stock back from investors.
So what happens in a widespread free-falling market? Well, you can just imagine the pandemonium on the trading floor as investors rush to sell their securities however possible. Traders and investors carrying inventory all lose money. At that point, no one knows where the market will bottom out.
On the flip side, in a booming market, carrying inventory consistently leads to making money. In fact, it is almost impossible not to. Any stock or bond held on the books overnight appreciates in value the next day in a strong bull market. This can foster an environment in which poor decisions become overlooked because of the steady upward climb of the markets.
Being long or short
Traders buy and sell securities as investors demand. Usually, a trader owns a stock or bond, ready to sell when asked. When a trader owns the security, he is said to be "long" the security (what we previously called "carrying inventory"). This is easy enough to understand.
Consider the following though. Suppose an investor wished to buy a security and called a trader who at the time did not have the security in inventory. In this case, the trader can do one of two things - 1) not execute the trade or 2) sell the security, despite the fact that he or she does not own it.
How does the second scenario work? The trader "goes short" the security by selling it to the investor without owning it. Where does he get the security? By borrowing the security from someone else.
The problems with shorting or short-selling stock are the opposite of those that one faces by owning the stock. In a long position, traders worry about big price drops - as the value of your inventory declines, you lose money. In a short position, a trader worries that the stock increases in price. He has locked in his selling price upfront, but has not locked in his purchase price. If the price of the stock moves up, then the purchase price moves up as well.
Tracking the Trades
Traders keep track of the exact details of every trade they make. Trading assistants often perform this function, detailing the transaction (buy or sell), the amount (number of shares or bonds), the price, the buyer/seller, and the time of the trade. At the end of the day, the compilation of the dollars made/lost for that day is called profit and loss statement, or P&L. The P&L statement is all-important to a trader: daily, weekly, monthly, quarterly - traders know the status of their P&L's for these periods at any given time.
Types of Trades
Unbeknownst to most people, traders actually work in two different markets, that is, they buy and sell securities for two different types of customers.
- One is the "inside market" which is a monopoly market made up only of broker-dealers. Traders actually utilize a special broker screen that posts the prices broker-dealers are willing to buy and sell to each other. This works as an important source of liquidity when a trader needs to buy or sell securities.
- The other is "outside market," composed of outside customers an investment bank transacts with. These include a diverse range of money managers and investors, or the firm's outside clients. Traders earn the bulk of their profits in the outside market.
- Not only do traders at investment banks work in two different markets, but they can make two different types of trades. These include:
- Client Trades. These are simply trades done on the behest of outside customers. Most traders' jobs are to make a market in a security for the firm's clients. They buy and sell as market forces dictate and pocket the bid-ask spread along the way. The vast majority of traders trade for clients.
- Proprietary Trades. Sometimes traders are given leeway in terms of what securities they may buy and sell for the firm. Using firm capital, proprietary traders, or "prop traders" as they are often called, actually trade not to fulfill client demand for stocks and bonds, but to make bets on the market. Some prop traders trade such obscure things as "the curve" or the yield curve, making bets as the direction that the yield curve will move. Others are "arbitragers," who follow the markets and lock in arbitrage profit when market inefficiencies develop.
Bloomberg machine: Bloombergs were invented originally only as bond calculators. (The company that makes them was founded by a former Salomon Brothers trader, Mike Bloomberg, who now owns a media empire.) Today, however, they perform so many intricate and complex functions that they've become ubiquitous on any equity or debt trading floor. In a few quick keystrokes, a trader can access a bond's price, yield, rating, duration, convexity, and literally thousands of other tidbits. Market news, stock information and even e-mail reside real-time on the Bloomberg.
Phone Monitor: Traders' phone systems are almost as complex as the Bloombergs. The phones consist of a touch-screen monitor with a cluster of phone lines. There are multiple screens that a trader can "flip" to, with direct dialing and secured lines designed to ensure a foolproof means of communicating with investors, floor brokers, salespeople and the like. For example, one Morgan Stanley associate tells of a direct phone line to billionaire George Soros. Associates and interns are always doomed to goof up a call with these phones, leading to quite a few choice curse words from a nearby trader.
Small Broker Screens: These include monitors posting market prices from other broker-dealers, or investment banks. Traders deal with each other to facilitate client needs and provide a forum for the flow of securities.
Large "Sun Microsystems" Monitor: Typically divided into numerous sections, the Sun monitor can be tailored to the trader's needs. Popular pages include U.S. Treasury markets, bond market data, news pages and equity prices.
