Psychology

Trade What You Know and Know What You Trade

Those who haven?t worked in the industry may not be aware that nowadays most investment bank traders will only trade one particular sector or cross rate or country. This has not necessarily always been the case. When I first started in the industry as an 18 year old trading Japanese warrants in 1989 all the banks involved in that market divided their trading books into alphabetical order. For example, I traded all warrants whose company names were from S to Z such as Sumitomo Chemical and Toyota. While this arrangement had seemed to work during the bull market years, it was only when the market got tougher during the crash years that banks realised that it would be far better to divide the trading books by sector as there was no discernable correlation between the contracts we were trading and it was possible for example for all traders to be taken short in say steel stocks because they started with different letters and were therefore traded by different traders.

Similarly, in recent years the number of traders who are allowed to trade a variety of products has been reduced too in an effort to smooth out the performance of trading desks. Without a doubt these are among the reasons why on the whole the performance of bank trading desks has become more consistent.

Futures pit locals also stood in one pit all day and every day and now that most futures markets are screen based the majority of consistently profitable futures traders still trade one contract or spread, day in and day out. By doing this traders become better acquainted with how their markets trade and get a better idea of where opportunities are in their market as opposed to risk. There is another equally important facet to this type of trading and that is by knowing his/her market a trader is less likely to incur losses from a lack of knowledge of that product. To illustrate what I mean by this I will describe a few situations that I have personally witnessed.

When the LIFFE floor was in full flow there were a few traders who arbitraged between the prices of Bund futures on LIFFE and the DTB (now Eurex). Both contracts had similar specifications and so this style of trading had little downside. When the markets went screen based, the French Exchange listed a Gilt Futures contract to compete with LIFFE. A group of very successful Bund arbitrageurs decided to arbitrage between these contracts and couldn?t believe their luck when the French contract listed with a large price discrepancy to the LIFFE contract. They began to short one contract and buy the other but the prices did not change. Eventually a third party I believe realised what was going on and contact was made with this group of arbitrageurs to explain to them that the two contacts had completely different specifications and while their prices were different their yields were the same. I believe that each arbitrageur lost in the region of GBP 75,000 in only a few hours as a result of this lack of due diligence.

Similarly a convertible bond team at a major US bank suffered huge losses from not understanding the intricacies of a new style of preference CB and they traded them as if they were standard CBs. In both these example we are not talking about inexperienced traders but traders with great experience and who were until then highly profitable.

These are just two of many similar instances that I can recall over my career thus far which is why I am such a firm believer in the due diligence process and why I advocate to my clients to know what you trade and trade what you know. Sometimes if you trade a contract or product which you know little about the opportunity which you think you are spotting is actually not an opportunity but a mistake. I saw this particularly with some highly intelligent quantitative CB traders that I worked with who would scan for great trades only to be told by a more experienced trader that there were reasons why they looked like great trades which were usually because of some specific market nuances. They were in fact not great opportunities and the ?cheap? bonds they had found wee cheap for a good reason!

I remember a trader at one bank that I worked at, upon moving from the Gilt trading desk to a general proprietary desk where he could trade anything, told me that he found his new position far harder. There were so many contracts and products to choose from there seemed like there were opportunities everywhere, whereas his experience told him that many of these ?opportunities? were more likely to be risk. He in fact asked to go back to the Gilt desk because he felt he could make far more money just trading that one contract because he knew it so well.

While banks and bank trades now realise that they will actually make more money by specialising, private traders believe they are knowledgeable about a variety of markets and trade accordingly. Often they are encouraged by technical analysis supporters who believe that the same methods of analysis can be applied to all markets. Indeed this is one of the reasons why technical analysis is so popular among private traders because it supposedly gives them a way of analysing any market they choose. Traders often scan hundreds or thousands of stocks or contracts through their chosen system looking for the ones which seem to offer the best opportunity. However in doing this they increase the chances of trading something they know little about and therefore open up the potential for losses such as those I have described.

Some traders initially think that their opportunities will be less if they specialise in one or two sectors, but what they find is that there are still enough to make money.  More importantly, their trading becomes more consistent and they start to eliminate some of the avoidable losses that dogged their trading from time to time. In fact even some technical traders have admitted to me that they seem to do better on the contracts that they know more about and acknowledge that rather than their technical skills being the reason for their profits it may well be their knowledge that is helping them.

As with all of my views and beliefs this is based solely on my experiences. When I began my trading career at the age of 18 I had not read any books or attended any seminars by traders. I have learned my trading from the profits and losses of myself and the traders that I have worked closely with. I guess this is one advantage of working on trading floors in that I have been able to watch others trade and do not have to rely on stories which may or may not be embellished. It is my feeling based on this experience that every trader would benefit from knowing what they trade and trading what they know.

Gary Norden is the owner of Organic Financial Group and author of An End to the Bull & Technical Analysis and the Active Trader. His 25 year trading career started at the age of 18 when he was Yamaichi's youngest ever trader. He has traded derivatives for some of the largest investment banks and was Head of LIFFE Options for NatWest. He now consults to professional and retail traders and mentors new traders. For more information visit www.organicfinancialgroup.com and www.anendtothebull.com.

Gary Norden is the owner of Organic Financial Group and author of An End to the Bull & Technical Analysis and the Active Trader. His 25 year tradi...

fxmarkets

Established member
834 50
"Trade What You Know and Know What You Trade "

" it was only when the market got tougher during the crash years that banks realised that it would be far better to divide the trading books by sector "

hmm It would also be helpful if you know how to trade, And I assume that because these now enlightened banks have now divided the books by sector, then come the next crash, all the banks will be short already waiting for those who do not have books by sector in a nice order to panic sell ( because of the disorderly nature of their books )

Now im just not getting this........ the banks blamed the jumble of sectors for losing money. oh dear oh dear, they really dont have a clue these banks.

"this assets just fallen 400 points because its in the wrong sector, hmm errr ummm, you best tidy them up then son, now if you had nice tidy books see you would of made money,cos that is so,say's ere' on this memo.. " :confused:


Maybe they are slowly heading towards

Know How To Trade You Will Know What To Trade And When To Trade It.
 
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Silent.Trader

Member
80 1
fxmarkets said:
Now im just not getting this........ the banks blamed the jumble of sectors for losing money. oh dear oh dear, they really dont have a clue these banks.
It doesn't sound that ridiculous to me as you make it sound fxmarkets. All depends off course on the trading style. But assuming that they don't want to much a marketexposure and trade roughly market neutral it does make sense. If sectors are mixed there's a fair change that all traders are short the same sector and long the same sector. By trading by sector they'll not only be market neutral over the entiremarket, but also per sector as every trader will stay roughly market neutral. I think that should reduce volatility (read risk) significantly.

grtnx
Wilco
 

SOCRATES

Veteren member
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This is real common sense for a change. I agree with your sentiments which are the result of experience, wholeheartedly. I am giving you a 10 for this. Whether what you say is constructively taken on board is another matter altogether. People are apt to pounce without considering the footprint of the instrument chosen to trade in. That is why specialisation is so important. With specialisation may come a niche and ultimately an edge for that particular niche. But the great majority are impatient and consequently assume they can pounce on anything just because it moves. As a consequence the result is the development of jacks of all trades and masters of none, I respectfully submit.


SOCRATES
 

fxmarkets

Established member
834 50
Silent.Trader said:
It doesn't sound that ridiculous to me as you make it sound fxmarkets. All depends off course on the trading style. But assuming that they don't want to much a marketexposure and trade roughly market neutral it does make sense. If sectors are mixed there's a fair change that all traders are short the same sector and long the same sector. By trading by sector they'll not only be market neutral over the entiremarket, but also per sector as every trader will stay roughly market neutral. I think that should reduce volatility (read risk) significantly.

grtnx
Wilco
hello Wilco.

Hmm now my knowledge of Banks trading is zero, so how could I comment? well just because your in a bank doesn't mean you are gonna make money.. you may be restricted.......?reading from the article I assumed these banks were engaged in speculative trading enabled by Opportunity to take advantage of volatility/risk and the article came across as these banks (traders who work in the bank) fell flat on their faces when opportunity to profit is favourable as I see it.

Is it speculative trading that banks are engaged in ? or something else which isn't trading as I perhaps label it.

Totally agree on the Know your onions aspect of it, that I assume is a very basic to the point that its a non starter in the equation. I would assume that the resources the banks have at their disposal they would be able to attract traders (for a while) who would know at what price it their product traded at 3 mins ago, 3 hours ago and 3 days ago.

Is it different in banks I mean if a traders long and his product that s/he is trading is not longing anymore

a) why havent they closed the long
b) why are they not looking for shorts
c) why did they lose so much money.

It reminds me of the fund managers who are experts at growth trusts unit trusts etc... whats going wrong... I understand that these managers often need to be invested or takes time to decide on what to do... but speculative traders taking advantage of price volatility ,hmm thats the point isn't it... ?? speed of action in that brief period of time is your friend not an excuse is it ?

open for learning here. Is it the size of money they need to shift which causes problems?
fx
 

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