Quantitative prop trader: ‘I wouldn’t try to raise the price of rice and starve China’

“Prop traders have freedom because there’s no client telling us what to do. On the other hand we have more responsibility because it’s not the client’s money but our own money, as a bank. Banks don’t like to advertise this, but prop traders like me are quite profitable in terms of income generated per head. This is very useful for banks in times like these.

“Prop traders come in two varieties, too. The ‘pure’ prop traders have a view on the market that day and act on that. ‘Quantitative’ prop traders like me have a systematic view, meaning I build strategies and then trade them longer term on the market.

“How that works: I will have an idea about a pattern in the market, say, if the share price of two English banks with a broadly similar outlook diverge, they will most likely converge again very soon; they have a broadly similar outlook after all. Or I might look at the ways unusual rainfall in Argentina translates into higher wheat prices.

“That’ll be my ‘idea’. Next is statistical analysis, where I go back to historical data and look at the prices of these two banks at every day, minute, or even second, over the past one, three and five years. I run analyses and if the pattern holds, I work out the threshold at which we should buy and then sell again these shares.

“I will also determine my ‘confidence range’: how likely is the pattern to play out? One in three, one in four? You need a strong correlation. Another thing to examine is whether the trade I am studying would, when executed, ‘move’ the market; so will the very price of the share be affected by my buying it?

“That’s what I do. By anticipating logical reactions to events impacting a particular share, commodity or financial product, I get ideas for trading. I mine the data for statistical confirmation, work out a trading programme to exploit those patterns and when the chance of actually making money on the programme looks good enough, we go for it.

“Developing ideas can take a few weeks or more. You need to check if it all works, if the data set does not contain weird numbers. There are a lot of good ideas around, but can you profitably trade them? Then there are the trading limits; I can only take this much risk and my strategy has to accommodate that. People may think of us as gamblers, we are actually very cautious and careful.

“Where I get my ideas? You grow into it. As a junior you start by helping on peripheral work for the team and you won’t trade straight away, especially not on other people’s ideas. Gradually you come into your own.

“Let me give you an example of a pure prop trading idea: Germany refuses to print extra money until the weaker euro countries structurally reform their economies. Only then will Germany solve the crisis by flooding the markets with money, creating inflation that will undermine the euro’s value and in turn help Germany’s export industry. The longer Germany waits, the more money it will have to print to solve things.

“That would be a ‘view’ and it will give a pure prop trader ideas for a trade. This example is more ‘pure’ than ‘quant’ as it has too few chances to occur several times over the next years – in other words, there is nothing really systematic.

“The following example is very ‘quant’: I’ll put all the major banks share price in Europe in a big matrix and add prices for currencies and interest rates. That’s my universe. Then one algorithm will compute a correlation rate for every pair in my universe in real time. If one correlation moves suddenly away from its average then you buy one and sell one. All the preliminary research is there to tell you what is ‘suddenly’, how to compute a realistic ‘average’ and how much is too far away for that average.

“A good market-making trader will have great instinct for how the market works, and is a very quick thinker and decider. Quant traders like me take more time, we are more rational and academic, if you will.

“Buying something on the financial market is called ‘holding a position’. There’s enormous regulation surrounding trading. In commodity trading (rice, oil, grain) you cannot hold more than a certain percentage of existing contracts in that commodity – to make speculation harder.

“The greatest misunderstanding about prop traders? That we’re evil. What outsiders are concerned about is speculation; if you trade large enough volumes you begin to impact the market itself, you ‘move the market’. I would never consciously try to raise the price of, say, rice, and starve children in China. Quite apart from the morals, it is actually very difficult to make a profit out of that. You drive up the price of something by buying more and more of it. The thing is, players in the market are going to notice that. And so they will quote rapidly higher prices to you since they realise that you want to buy a large chunk of the overall market with all your money. It is absolutely forbidden to do a quick in-and-out when you’ve pushed up the price yourself. It’s called price manipulation and regulators are really strict about that, you get sanctioned even if it happened by mistake and was really unintentional.

“Why not work for a hedge fund where there are more people like me? Well, hedge funds work with other people’s money, and they can suddenly go into a panic and take their money out. That kind of thing can really wreck your strategy. In a bank I can take more risk because I don’t measure risk in terms of cash but in profit volatility. A hedge fund investor would get very alarmed by a negative performance spanning over a few weeks and even months. Not a bank. But the bank would be alarmed if you have large gains one day and large losses the next one. The bank can afford to back you for some time when you’re down. Provided what you do doesn’t look like gambling. Indeed, when my profit for the day is extremely large, I need to justify it. It does not matter that it makes a nice profit.

“I met this guy the other day who was working as a prop trader in 1996. This was when you would take a piece of paper with your order on it to the trader. In 15 years things have changed so much that he can no longer do it; technology has made it a new job altogether.

“The fact that traders work in teams impacts your work. When the guy next to me loses money, it eats into my profits. Also, we share risk limits. Traders take positions on the market, and these positions entail risk. Banks add up all that risk, which has to stay within so-called risk limits. What this means is that together traders share those risk limits; the more one takes, the less there’s left for the other.

“Quant prop traders like me are very, very cautious. We go for small gains while exposing ourselves only to small potential losses. It’s called going long-short. I may have a view that gold will go up. Now the prices of gold and silver usually move in tandem. So what I do, I buy a financial product that will increase in value when the price of gold goes up, coupled with a financial product that will increase in value when the price of silver goes down. This way I am ‘hedging’, you see? Either gold will go up and I will make some money – but not a whole lot because the ‘silver-product’ will lose me some. Or gold will go down and I will lose money on that – but compensated by the increase in value of the ‘silver-product’.

My salary is £150,000 a year plus bonus. This bonus can dwarf my salary and be multiples higher. In this business you can exactly pinpoint profits, and people like me get paid roughly a percentage of those profits. This is very different from deal-making like mergers and acquisitions. There it’s teamwork over a number of years that might bring in a deal. In such a context it’s impossible to identify what one particular person contributed.

“Since performance is measurable, prop trading is incredibly meritocratic. I work with some of the smartest guys in the world. It’s enormously challenging and edgy and exciting. Once a year the bonus comes in and that’s very nice. But do I stay in this business for the money? No way. If I weren’t happy every day, I’d leave. I have options. For somebody with my mindset this is the best job in the world.”

Later, I ask him three more questions via email:

What is the greatest moral dilemma you face in a job like yours?

“Surprisingly, it’s one you have to face every day. Around noon to be precise. It’s the question: what am I gonna have for lunch today? We can spend close to 12 hours in front of a screen, so the few minutes we have to grab and eat lunch have to be spent well. Imagine you’re stuck with a burrito while all you wanted was a chicken sandwich! You’ll have to live with your food decision all day. More if you get food poisoning.”

What is the hardest thing to master in this job?

“I’d say honesty. When you work on a new strategy you might find something that will make profits, all you want to do is go fast and start trading your idea. But you have to be honest enough to admit that you don’t know everything. There is a lot of money at stake, we can make mistakes in the calculation or underestimate the risks. It takes a lot of humility to admit that you can be wrong, especially in our competitive environment. Once you have accepted that and take enough time to check all the details, you’re a good trader.”

What skill do you wish you had?

“None! Do I sound enough like a trader by saying that? Seriously, a lot of people would love to have my spot. I did not end up in this job by chance. I worked my way up step by step. From uni to internship, from job to job. So if there is a skill I want to have, then I work on it. That would be my message to the world, or at least your readers: empower yourself. It’s not easy but that teaches humility and confidence at the same time.

“Speaking of humility, which I might seem to lack now, I wish I had any artistic skill. I can’t sing, paint or play any instrument. But give me some time and I’ll work on it.”

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