Career: Trader vs. Quant - Pros and Cons for Physics Graduates

[Onamor]

Hey, thanks for the article. Yes, these things are always interesting, and such success stories not even too uncommon. But I agree, it's very rare to get a decent look into what the hell it is that traders/hedge funds/banks do.

But I'd like to bring something up just for arguments sake,

Of course some traders are better than others

Why "of course"?!
Such stories like this are just a small (overly focused on) view of a much larger picture. For each Cohen, Soros and Buffet, I bet there are a million or so people who lost money. Or worse yet, made a lot of money, then lost that too. I bet there were times when each of these great and very wealthy speculators were very close to bankruptcy. If they had gone under, would you ever have heard of them?

I would argue that this is not the norm for an investor - to be "right" over and over again.

 

[snowjoke]

You're right that for every winner there is a loser - that's what I meant by saying that not everyone can be better than average - but it's not necessarily random who the winners are. Being a good trader can range from not making mistakes, to acting on information more quickly than others. Ask yourself why Goldman Sachs makes so much money from trading every year, while 80% of day traders sitting at home lose money.

 

[Onamor]

It's a good point, but are Goldman http://www.reuters.com/article/idUSTRE6781YC20100809"? Why not, if they know what they are doing? Scientific experiments are repeatable.
If you take the traders out of Goldman, sit them at home and have them trade like a day trader, I'm not sure they will do better. Else, why do they insist on trading from inside Goldman offices? Do they enjoy sharing their profits with the company?

I'm well out of my depth here, but I'd say that companies can have an edge from information and other external influences. Not a closed system I suppose.

 

[snowjoke]

Trading isn't a scientific experiment. Markets are largely stochastic rather than deterministic. You're sometimes right and you're sometimes wrong. You make money if you're right fractionally more often than you're wrong...

 

[Onamor]

Trading isn't a scientific experiment. Markets are largely stochastic rather than deterministic. You're sometimes right and you're sometimes wrong. You make money if you're right fractionally more often than you're wrong...

Completely agree. But are you saying there are strategies that are always right more often (even fractionally) than they are wrong? This is in essence the same thing, no?

 

[twofish-quant]

If this activity called trading is contrived and not really useful, surely one day (at least in a decent/honest/ideal society), it will cease to exist?

Let me tell you what a trader does.

I want to sell 100 shares of Exxon stock so I go to my computer and issue an order to sell 100 shares of Exxon stock. Now it is likely that somewhere in the world someone in the world wants to buy 100 shares of Exxon stock, but the odds are that they are not staring at the computer at the exact moment that I want to sell my stock. I could sit around at my computer screen for hours on end waiting for someone to buy my stock, but I have better things to do.

So you can pay someone to sit around for hours on end staring at a computer screen looking for someone wanting to sell 100 shares of Exxon stock and then wait for someone wanting to buy 100 shares of Exxon stock. That's a trader.

But wait... Now that we have computers, can you program a computer to automatically look for people wanting to sell stock and then match them with people that want to buy stock. Sure. That's algorithmic trading.

If no trader really knows what they are doing, there could still an argument for having traders - lack of a better system..?

I said that the price of stock is random, that's a different statement. If a trader has just bought 100 shares of Exxon stock, their job is to find someone that wants to buy 100 shares of Exxon stock as fast as possible so that they can make money off the difference. Traders do not buy and hold because the longer they hold on to stock, the higher the chances that "something bad" will happen. So someone that trades Exxon doesn't care whether Exxon rises or falls.

Now portfolio managers do, but that's a different job.

But if they truly understand, why aren't they always right? Personally I don't think you can be a better trader than someone else.

Part of true understanding involves knowing what you don't know. Traders in general try to get rid of their positions as quickly as possible. I buy Exxon stock, I sell Exxon stock. The reason that people want to do this is that if you have a position something bad could happen, and your job is to provide liquidity and not to gamble on the long term direction of Exxon stock. You don't care what Exxon is going to do in a month. If you are a human trader, you are buying and selling on the order of hours. If you are a machine trader, you can react in milliseconds.

I love this situation. Just because somewhere there could be a kid with a coin beating Goldman (Or a monkey and a typewriter...)

There almost certainly is. The thing about random processes is that someone somewhere will win the lottery. If you have enough monkeys typing random stuff in a typewriter, someone will make insane amounts of money. You can mathematically show this to be the case.

But the difference between luck and skill is that your luck will run out. If you have someone win a lottery, the chances that they will win the lottery again isn't high.

Anyways, I think if I don't aim on making more money than anyone else, just to make money, then it doesn't matter how often I flip my coin?

Yes. Transaction costs. Every time you flip the coin, you have to pay someone something.

 

[twofish-quant]

http://www.businessweek.com/magazine/content/03_29/b3842001_mz001.htm" to an interesting article I read recently about Steve Cohen, whose company makes millions of dollars per day from trading. It's a bit old and markets have probably changed, but it provides good insight into active trading.

It really doesn't. Part of the reason people have huge misconceptions about finance is because of articles like these. One problem is that it gives people extremely inaccurate ideas for what most people in Wall Street actually make. Yes, if you run your hedge fund, you can make huge amounts of money, but you can also make huge bucks running a technology start-up.

Cohen is a hedge fund manager. His company trades stocks, but he isn't a stock trader (i.e. a market maker).

 

[twofish-quant]

Hey, thanks for the article. Yes, these things are always interesting, and such success stories not even too uncommon. But I agree, it's very rare to get a decent look into what the hell it is that traders/hedge funds/banks do.

I wouldn't post as much as I do, if there were better sources of information. People get their information from the movies and from articles about mega-millionaires, but that gives you a *really* bad idea of what people in banks do, and that distorts decisions making.

For example, people think that everyone that works for an IB is a mega-millionaire, which makes people drop everything to work at an IB and forget about working at Google and Microsoft. If people got a better idea of what the real salary levels are like, then maybe Google doesn't look that bad.

Salaries in finance are "good". They aren't insane.

I would argue that this is not the norm for an investor - to be "right" over and over again.

Correct, and its a big, big warning sign if you are making too much money. One thing that you absolutely have to do is to know when you are investing and when you are gambling. Gambling can be OK, you just have to realize when you are going it, and make sure people whose money you are using are also OK with it.

Also, you have to think economically. I can imagine arranging the world economic system so that everyone in the world makes say $200K/year. I can't imagine setting things up so that everyone makes $20M/year.

So if someone offers a whole bunch of $200K jobs, that seems sustainable. If someone offers a whole bunch of $20M/year jobs, then I get suspicious since I don't see where the money is coming from.

 

[twofish-quant]

Ask yourself why Goldman Sachs makes so much money from trading every year, while 80% of day traders sitting at home lose money.

Because day traders have to go through GS in order to get to a counter-party.

Let's suppose you are a "day trader" (and I use the words in quotes since no one that I know of that day traders is actually trading). What do you do when you have to buy or sell a stock. You go through a broker.

***BZZZZTTTTT*** game over, you've just lost.

You make money from trading by *being* the broker. However being a broker requires lots of money. You have to have dozens of lawyers and then you have a lot of computers, and then you have to hire a ton of people to run the computers.

Which is where I come in...

Also trading as an economic activity generates value. It's a good thing that I can go online right now and sell 100 shares of Exxon and get cash for it.

 

[twofish-quant]

Markets are largely stochastic rather than deterministic. You're sometimes right and you're sometimes wrong. You make money if you're right fractionally more often than you're wrong...

That's one way to make money. There are others.

 

[Onamor]

Hey, thanks for your replies, particularly this part;

Let me tell you what a trader does.

I (and I'm probably not alone in this) have read books that simply don't state this as clearly as yourself, so thank you for that.

But could I throw you another question?

Now that we have computers, can you program a computer to automatically look for people wanting to sell stock and then match them with people that want to buy stock. Sure.

Why do we have have human market makers at all? Surely they must inject some kind of (human) prejudice into the process? Not just buying at the lowest, selling at the highest - a computer can do that as well...

 

[twofish-quant]

Why do we have have human market makers at all? Surely they must inject some kind of (human) prejudice into the process?

If that human prejudice includes wisdom and intuition, that's a good thing. Suppose you have a $1M position on Exxon stock. It's now down to $950,000. Then it goes to $900,000, and $850,000. If it hits $800,000, and you haven't closed the position, the system will automatically close the position since you've exceeded your trading limits, and bad things will happen to you.

So what do you do? If you've been trading Exxon stock for years, you'll have some idea as to whether or not to take the loss.

It should be noted that there is a human bias not to take losses and keep to a losing position rather than admit defeat. That will get you killed as a trader which is why most people don't make good traders. What happens is that traders have a trading limit, and if you exceed those, it's like maxing out on your credit card. Bad things happen to you.

As far as how those limits are set, there's another group of people that deal with that.

Not just buying at the lowest, selling at the highest - a computer can do that as well...

Computers can't think. What they *can* do (and do in fact do) is process vast data at millisecond frequencies.

Sure if you have a bunch of computer programmers programming the system and a bunch of traders that know the markets well enough to input trading strategies, but at the end of the day the computer is just a tool, and you need people to tell it what to do.

For example, one thing that the traders do tell me is not to try buying at the lowest and selling at the highest. If you try to time the peak, you'll always miss, and lose your shirt trying.

 

[Onamor]

Sorry, I don't think we're on the same page here. I was asking about why we have market makers - the guy that sits at the computer to match buyers and sellers. He just provides liquidity, and makes profit from the spread, if he sells higher than he buys, or vice versa.

The guy I think you were referring to here;

If a trader has just bought 100 shares of Exxon stock, their job is to find someone that wants to buy 100 shares of Exxon stock as fast as possible so that they can make money off the difference. Traders do not buy and hold because the longer they hold on to stock, the higher the chances that "something bad" will happen.

As far as I know, in broad terms, there's proprietary traders and market makers. One trades when he thinks he knows a profit opportunity and the other provides liquidity.
Why can't a computer do the job of the market maker? Do they do something else?

Sorry if it seems I'm hammering on here, but sometimes you have to ask the simple questions... So thanks again for any replies.

 

[snowjoke]

There are different types of exchanges for different instruments. For very liquid instruments, you have an automated order book system, where buy and sell orders are placed (which can be at limit, where maximum/minimum price is specified, at best, where you fill the order based on what's already on the book) and automatically matched. For less frequently traded instruments markets tend to be quote-based, i.e. the market maket provides a bid and ask price at all times. It's his job to decide what these prices are. For even more exotic and illiquid instruments, they might not even be listed on an exchange, and selling it might involve phoning up clients and negotiating prices.

 

[twofish-quant]

As far as I know, in broad terms, there's proprietary traders and market makers.

There are also other permutations of this. For example, there are portfolio managers that look for profits, but for pension funds, insurance companies, mutual funds, etc. That's another set of players.

One trades when he thinks he knows a profit opportunity and the other provides liquidity.
Why can't a computer do the job of the market maker?

They often do, but then someone has to program the computer to recognize market signals. In some markets, computers do badly either because there aren't enough trades to justify the expense of a computer, or because there isn't a single market, or because computers just aren't as good as human beings for recognizing market signals. Other markets are now dominated by computer trading.

Just to give one example in which computers aren't that good. If you want to trade Exxon stock, then there is only one real type of Exxon stock. If you want to trade a contract on the price of oil, there are a huge number of ways you can structure that, and so to place the order you have to be on the phone for a while getting the exact details of the contract.

Finally, you need a human being to recognize when the machine is going haywire and to shut it off. Most markets have a rule that say that if the index moves more than X% in Y minutes, then the computers get shut off and people have to execute orders by hand so that people can figure out what happened.

The trend over time has been for trading to become more and more automated. At one end you have market makers that just put in an algorithm and let the computer run. At the other end, you have people sitting in from of computer screens, but even they use a lot of compute power so that they can display the data in ways that they can find what they are looking for. And you have various combinations of man and machine in between.

But curiously more automation means more humans are involved. Computers don't program themselves, so what often happens is that you have programmers create a trading platform that takes canned strategies from traders and executes them. Even in the area in which people are making the trading decisions, they rely very heavily on computers to display information in some way that they find comprehensible.

The other thing is that computers just break down sometimes, and when you have computers making a lot of the decisions, it's a very, very bad thing when the computer just stops working suddenly. At that point you bring in a team of tactical programmers to fix the system, and that sort of work is very interesting.

Also, in some markets pretty much all trades are automated, so that point it's a fight between who has the better computer programmers.

One analogy is that traders are like race car drivers, but to get anywhere as a race car driver, you have to have a good pit crew and great engineers to design your car.