Risk management in HF or trading Desk 2...
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Trader: the business .. ?!! ..or the "game" ..
To understand the trader's business, you first need to know what a trading room is. It should be remembered that, originally, the role of a bank known as "disintermediation" is the provision of a priori free of charge and its expertise to serve its clients. So how does it make a profit? At the same time, a bank uses its expertise for its own account. All the profits come from the volatility of financial assets, which is more simply called risk. It is by taking risks that the bank wins (or sometimes loses) money. The role of the trader is there. It has two main functions, which it can exercise simultaneously or not: manage the risk and speculate. These two roles cross all his profession and according to the respective dosage of one or the other, it will bear different names.
Market Hall Traditionally, a market hall is organized as a double entry table, vertically and horizontally.
The vertical classification is that which separates the treated products. They are born of 5 types of risk, which are called underlying. These underlying are as follows:
Credit risk: Risk arises from the likelihood of a company or a state defaulting on its debt. The product treated is similar to an insurance which protects its buyer from a possible defect, that is to say an event that would cause the company or the State to be unable to honor its debt . The buyer of this insurance is therefore a person who has a claim on the company or state concerned. The trader gives a price to this insurance depending on the risk incurred. For example Russia is more likely to default than the US therefore the insurance on its debt is more expensive. Then, depending on economic or political conditions, the price of insurance varies. "Credit quality" is said to vary. And depending on the price at which the insurance was sold or purchased, the trader realizes a loss or gain. These products are the most recent on the market and are the ones that are developing the fastest. They are also the ones with the most future.
Fixed income: the risk arises from the movement of interest rates, which are decided by the central banks. If you borrow 5% today for a year and suddenly the central bank decides to lower its rates to 4% per annum, you can only lend your money to 4%. You will have lost money. It is the second largest market in terms of volume in the world. A contract for a nominal value of several hundred million dollars is not a problem. It is called the fixed income or debt market. Swaps and bonds are treated primarily on this market. It is the most technical market mathematically and where one generally finds the engineers.
Equity risk is the most well-known risk. It is tied to business activities. It is a small market compared to the debt market. Nominal exchanges of the order of a million dollars are the norm.
Exchange rate risk (FX): is the exchange rate risk. It is the largest market in the world with a daily volume of 2,000 billion dollars, constantly increasing.
The risk of commodities: a small market compared to foreign exchange or debt, but also booming, the risk is linked to the price of raw materials.
Horizontally, the room is separated into four main branches, which separate functions between traders.
Two main categories distinguish the subsidiary of structured products from that of the basic products (swaps, shares, exchange, etc.) called "vanilla" products.
The "market maker": working on commodities such as the spot (currency exchange) cash action, government bonds etc. The market maker only responds to customers by quoting two-way prices, a price where he agrees to buy and another price where he agrees to sell. The positions he holds are the consequence of the deals he achieves, and he must always cover these positions, while trying to make a profit. But the market maker is not supposed to be speculating. It must respect strict position limits. Most often young recruits begin with a market maker position, which allows them to apprehend the market by taking little risk.
The trader of vanilla products: the vanilla products are those that generate the most revenue in the room. But these profits represent only 60% of the total and are constantly decreasing, competing with structured products. Revenues come from very few margins (even if there are), and much more from speculation activities. For example, a 100 million euro swap deal may yield a margin of 5000 euros. Profits usually come from speculation. Will the price of gold rise or fall? Did the Federal Reserve show these rates at the next meeting? etc. By trader, income varies greatly depending on the activity. What motto is it, what market, what region of the world, but above all is it a good speculator or not? And a priori no need of diploma, the recruits being most often young people of 20 to 23 years without experience but enthusiastic, that the bank educates to its own models among the professionals...and not always they succeeded .
Same professional statistics show that just 2% succeed to cross the 5 years barrier and just 0,2 % succeed 10 years of trading .
The structured products trader: structured products are the most fashionable at the moment and the profits they represent are rising sharply in recent years. These products often offer a complex indexation of profitability on different vanilla products. The profits generated then come from the margins taken by the bank during the transaction. As it is generally difficult to give a price with certainty to exotic products (since they generally do not exist), and there is no liquidity in the market to cover them perfectly (they are often issued Unity), these margins are important and even monumental. They are pure risk managers, they do not speculate since only one deal can sometimes bring in 500,000 euros. This branch usually employs former bank researchers or young graduates who are destined to become one and who have an inclination for business.
The "proprietary trader" ("prop trader"): privileged bank, the traders have carte blanche to speculate with the bank capital in all the markets. Unlike the market maker, it does not rank customers. High-risk business but one of the highest-paid in the world, it entitles a percentage of earnings. If the trader of structured products can generate 50 million euros a year, he must share the profits with the structuring, sales and research teams. The prop trader easily generates this profit but does not share it with anyone. Its position is very coveted, but represents an exception in terms of age within the room since the traders are the most experienced traders. Prior experience of 10 years in trading is the norm.
Most of the trading desk before 20 years ago don't use any criteria of risk and management .Traders and risk analysts in the middle office often do not have a shared awareness of how inter-connected they are, and many errors that result in financial losses occur due to misunderstandings between these teams.”
Although financial trading and aviation appear very different environments, they are both fast paced, highly skilled, technically complex, and dependent upon the social skills of operational staff.
Errors are caused by similar behavioural problems (e.g. problems in teamwork and decision-making) and Meghan is examining whether the methods used to improve risk management in the cockpit can be applied to the trading floor.Communication happens very fast on the trading floor and – similar to aviation – traders must manage risk under high levels of uncertainty and stress.To work effectively, traders and trading teams need the skills and attitudes that will help them to manage risk effectively and to respond to an uncertain and dynamic working environment
The trader therefore manages his book with a greater or lesser freedom. The prop traders are pure speculators. Traders of vanilla products have an intermediate position since a large part of their profits comes from speculation. Their job is to rate customers, like market makers, but also to speculate on their market, which they know well. Generally their positions of speculation, which can rightly be called prop trading positions, outnumber in volume from 5 to 100 times the positions of market making. Traders of structured products also occupy this intermediate position but generate mostly profits through market making (across margins). Their prop trading positions are largely relegated to the background and often they do not even have them. The market maker is the one with the least room for maneuver.
Become a trader, end trader
Amphitheater Let's say it right away, the recruitment processes of traders are very competitive. French banks are the most picky on diplomas and some much more than others. But the biggest banks in the world are all Anglo-Saxon (American or English). And here the question of diplomas is less a question, even if it is sometimes the case (especially where there are "nests" of French graduates, which happens regularly, with the mathematical skills of the French being appreciated).
That said, there are a host of modest banks and brokerage houses where profits do not amount to hundreds of millions of euros per trader, but they offer opportunities for less qualified graduates. It should also be pointed out that success in trading does not always take place through diplomas (as Anglo-Saxon banks have well understood) but often by a talent unique to traders to understand the market and anticipate its reactions. This means that if someone shows up, even in a small "shop", he has every chance of being recognized and then accessing larger capital. These are not isolated cases. American banks are full of "self-made" prop trader. Nevertheless a fundamental criterion for success in this path of "without diplomas" is age. The sooner a trader begins to make money, the more chance he will have of accessing large funds. And this has the advantage of being independent of the bank since the trader who shines, shines on a market, not just on a trading floor... will be continue ... next week