Anton Kreil Explains What A Trader at an Investment Bank Does

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Let’s start at the investment bank then where you’re all going to apply trading and portfolio management so if you’re a professional trader at an investment bank if you’re a professional trader at an investment bank 90% of your time is spent being a market maker you make markets in the assets that you trade to clients 10% of your time is spent as a proprietary

Trader so using the bank’s money to make money and it’s called proprietary trading because it’s really everything that the trader does that’s proprietary to doing business with clients so it’s going to be pretty important to work out if you’re all applying to investment banks what the hell a market maker does because that’s what you’ll be doing 90% of the day

If you go there for it for 10 years you’ll be doing it for 10 years so you need to know market making on the secondary market side is the bread and butter of the business and it splits up into two areas agency and risk business it’s the bread and butter of the business because it’s the commission business it’s the backbone of all the profits of the company i’ll

Explain in more detail why as we go along it becomes very very obvious these days a typical commission on the secondary market side in equities is 5 basis points so 100 basis points is 1% typical commission is 5 basis points so if we’re looking at an agency example and by the way agency is 80% of all market making business these days we can use this example it’s very

Very straightforward a client a hedge fund or a pension fund of the bank on the secondary market site decides they want to buy ten million dollars of apple up five hundred dollars a share so they want to buy twenty thousand shares in apple they’ve got two choices when they call the investment bank they can either give it to the investment bank to execute on their

Behalf in the market where the bank does it with no risk or they can ask the bank to commit capital so ask the bank full risk agency is when the investment bank takes no risk they buy it on behalf of the client now that can be done over the telephone or it quick or it can be done over the computer so the client can actually put the order into the order management

System and it goes directly to the investment bank pops up on the screen of the salesperson the salesperson clicks send it goes to the trader the trader clicks right mouse send to the computer the bank hasn’t taken any risk they’re buying it on behalf of the client when it’s done over the phone the dealer at the pension fund or the hedge fund calls the salesperson

And says take an order for 20,000 shares in apple to buy at five hundred the sales trader enters it and sends it to the trader the trader accepts right mouse’s puts it in the computer either way it goes in the computer but in this example let’s have a look at the way the business works in this example the clients decided to buy ten million dollars of apple twenty

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Thousand shares the bank gets paid five basis points for just doing nothing whether it’s put in the machine by the client directly all done over the telephone any capital it’s risk-free what about the risk business the risk business in market making that transaction is done slightly differently this makes up about 20% of all market making so instead of the order

Going directly to the bank or via the salesperson directly to the trader or via the salesperson and put in a machine they’re going to the salesperson and asking the bank to commit capital so they ask the trader via the salesperson to sell the 20,000 shares to the client the trader ends up short 20,000 shares and has to go into the market to buy them back if this

If the stock goes down they obviously make money if the stock goes up they lose money market makers are measured on their ability to retain the commission that the bank is getting paid so imagine if you’re running your business on the trading desk one of the investment banks and over the whole year you get paid fifty million dollars commission the bank gets paid

Fifty million dollars commission for you to do that business to bring that 50 million in you had to commit capital in at least 20 percent of the orders so let’s say you lost 10 million dollars doing that well you’ve got a retention ratio of 80% which is very good in this example the retention ratio 60 percent so a bad retention ratio is 50 percent a good one is

75 your your ability as a market maker is measured on how much commission you retain so market making it’s what 90 percent 90 percent of the time traders are market making at investment banks not prop trading this is what you’ll be doing the vast majority of your day that’s what you’re applying for it’s split up interagency and risk business but 80% of the time

It’s outsourced to a machine and 20% the market maker is required to take risk to the client so we’re just doing 80 times 90 here 72 percent of the time a professional trader these days at an investment bank the day is spent monitoring software it’s spent monitoring algorithms because the software the algorithms are processing agency orders and they might they

May have lots of these all happening at the same time so 72% of a traders time is spent at an investment bank monitoring algorithms does that sound sexy there’s there’s no human skill in market making anymore ten years ago there was however the industry has been in structural decline for over a decade what you’re applying now to is a totally different industry

To what it was ten years ago what was the typical commission number that we looked at before can i remember five basis points what do you think the industry standard was ten twelve years ago i wish almost it was around 25 basis points was industry standard ten twelve years ago now if commission is the bread and butter of the secondary market side and it’s gone

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From 25 down to five that’s down 80 percent what do you think’s happened to everything at the investment bank because everything relies on it everything’s down 80% this is the problem that you face now the other 18% of the time of the market maker if you think about that trades that we looked at in apple where the market maker commits capital and sells the apple to

The client do you think that trader actually wants to do that trade well it’s a catch-22 situation because when the client comes in and says i want to buy 10 million dollars of apple 20,000 shares can you sell them to me at five hundred the trader says no three seconds later the trades done at the investment bank around the corner there’s competitions still in the

Industry of course there is so they’re kind of forced to do the transaction they don’t really want to do it they don’t want to commit the capital but they’ll do it if on balance it’s worth doing so they’re kind of forced to do it so the other 18 percent of the time unfortunately what you’ll be doing at an investment bank these days is putting out fires you’ll be

Unwinding positions that you don’t want to have so 72% of the time you’ll be watching machines trade making sure they’re not screwing anything up if they screw it up you do a right mouse you pull the order out the market when the machine behaves or wants to behave you right mouse and put the order back in the market the other 18 percent of the time you’re scrambling

Around to get out of risk that you don’t want that’s the job of a market maker that’s 90 percent of what a trader does at an investment bank that situation where you’ve got lots of positions that you don’t want to have that is termed in the industry as the negative selection portfolio those positions have been negative negatively selected you didn’t really want to

Have them you got given them by the clients and now you’re spending your time trying to get out of them so 80 to 90 percent of a professional traders time at an investment bank it’s not spent actually taking or trading positions that they want to have it spent market making and monitoring algorithms the machines in market making have replaced humans in the business

There’s no skill in market making anymore now we’re going to come on to pay later what people get paid it investment banks but it seems pretty logical that if the commission is down 80% over the last decade what do we think pay is that it’s down roughly by the same amount but first we’re gonna look at prop trading prop trading is pretty much 10% over traders time

That’s an investment bank that’s using the bank’s money to make money why do you think the bank would give the trader capital to enable them to take positions obviously to make money but why do they want them to make money doing this think about that negative selection portfolio over many many trades over a year over a financial year there will always be a loss

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In doing business with clients because they still have to commit capital so they will always lose some of the commission over the year and they’ll always have that the negative selection portfolio throughout the year but why do you think the bank gives the money to trade on a proprietary basis any guesses exactly so the bank gives them a pot of money to trade with

In positions that they want to have so they allow them to tattoo have or invest in a positive selection portfolio and that number that’s given to them is designed to make a return that outweighs the loss committing capital and doing business with clients so that example earlier 50 million commission over a year lose 10 million of that commission doing business

To generate the business to come through the door the bank make might give you 50 million to make the 10 million back in positions that you actually want to have and typically and this goes against pretty much all perceptions outside the industry typically they’re running long short portfolios with one to three month time horizon they’re not actually going in and

Out the market every couple of minutes every couple of hours trying to make money quickly they’re actually holding positions for a long time so they’re running portfolios so the purpose is to try and make that money back but it’s also linked to the traders bonus that’s where the trader gets paid their bonus if they make money proprietary trading in positions that

They want to have that’s where their bonus comes from now if commission is the bread and butter of the business and it’s down 80% in the last 1012 years what do you think the number is in terms of what the bank gives traders to enable them to trade within the proprietary trading account how much do you think that’s done about the same because that commission number

At the bank is collateralized to enable the traders to take more risk so if that’s down 80% the number that they give to the traders is down at 80% these days you’ll be lucky to get 50 million dollars even as a senior trader whereas junior traders 10 years ago we’re getting 250 million dollars so they could actually earn a bonus so that means all things being equal

Bonuses are down 80 percent am i depressing people here you don’t need to get depressed you’ve just got to deal with the market that you’ve inherited when i joined the industry in 99 well in all times or points in time it’s a traders job to follow where the opportunities are where the money can be made in 9899 when i was applying to investment banks it was valid

Because investment banks were places where you could make a lot of money it’s totally changed now what you’ve got to do now is deal with the market that you’ve inherited and still follow where the opportunities are but will come under that later

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Anton Kreil Explains What A Trader at an Investment Bank Does By InstituteofTrading