Trading away from the banks and institutions
by Christopher Butcher, 10/07/2016
The common attitude of trading in this day and age is that the best and only place to be successful is within a large financial institution such as an Investment Bank or Hedge Fund.
We are seeing the beginning of a new trend, formed because of continuous advances in technology, regulation and competition amongst brokers. And they are all in favour for the retail trader.
Since the 2008 crisis, the people have blamed the banks for their greediness, at the time for selling loan packages to investors whilst themselves betting that the packages would fail. This resulted in numerous Government bailouts all funded by the taxpayer.
This behaviour resulted in much heavier regulation on the large institutions in the form of minimum capital reserves and limitations on risk-weighted assets.
Likewise, the media has shed light on the further greediness of the bankers when they have been rigging the Foreign Exchange and Libor rates to falsely give the impression of a very healthy balance sheet. They also colluded and used the combined knowledge of large client orders for short-term profit, all at the expense of the client.
So what has happened since then?
The new rules imposed by the regulators essentially removes more of the loopholes used by the institutions to make a quick profit.
In the Foreign Exchange market, the benchmark for a price in a trading day is determined by the rate at 4pm (London time). A client will therefore say to the bank I want to execute this trade at the 4pm fix rate, also known as the WMR.
Over the course of a trading day, the bank will have a list of various client orders to execute at 4pm. In recent times, traders from different banks have been gathering together in online chat rooms to discuss their client orders yet to be executed at the 4pm fix. Collectively, the size and nature of the orders means that the traders involved in the conversations have a high probability chance of knowing what the market is going to do at 4pm. The traders will then execute their own trade just before 4pm and close it just after, knowing that the large client orders to be executed are highly likely to move the price in their direction.
The result? The trader profits and the client has been used as bait to do so. This is front-running at its best.
Since this activity has emerged, the new regulation has introduced a larger time window for the fixing rate; from 1 minute to 5 minutes and institutions are now largely encouraged to execute their client 4pm fixing orders away from the prop trading desk and more towards complete automation via an electronic desk. This is because electronic execution segregates the orders from those who can benefit from the knowledge of what trades are going to be placed.
To fund such electronic transactions, the clients are being charged more for the execution and as a result the business activity is going into a steep decline.
All in all, trading for a large financial institution is becoming more challenging and pressured than ever. There are more and more rules making the overall goal of profitability less and less likely.
Now let’s look at the modern bonus structure for your typical Investment Bank. 80-90% of your annual bonus will be given to you in shares of the institution you work for. The rules are that you cannot sell these shares for 3 years, and if you decide to leave the bank, you sacrifice your shares. Just like a mouse is attracted by the cheese in the mouse trap, if you want to work for a large institution expect to find it very difficult to leave.
The good news for aspiring traders is that it is becoming easier and more accessible to become a success at trading – but not via the corporate route.
Success in trading is all about having an edge. For the Foreign Exchange traders discussed above their edge was knowing what a large group of clients were doing at the same time (until they got found out).
People may not realise it, but trading for yourself gives the opportunity of having a number of advantages over trading for a financial institution.
Firstly, you are nowhere near restricted by the amount of regulations that corporate traders face. Furthermore you are not affected by company policies. You do not have to think about risk-weighted asset usage, the risk rating of the clients you trade with or capital reserves. The list goes on.
If you trade for an institution, you are paid to trade. At times when you believe the markets are showing no signs any direction, the best trade is no trade.
As a retail trader you have the freedom to decide not to have any open positions. If a corporate trader had no positions, they would probably be down the job centre by the afternoon.
Another factor to consider for retail traders is the competition amongst brokers. This competition is so fierce they try to win your business by reducing spreads. This means that you have access to prices as tight as those accessed by the corporate traders.
Combine these factors with the continuous technological advances and easy-to-access trading platforms and we are giving birth to a new era.
And the advice for the aspiring traders of today is to put down your CV and pick up some advice on how to trade!
Questions regarding this article?