Proprietary trading occurs when a firm trades stocks, bonds, currencies, commodities, their
derivatives, or other financial instruments with the firm's own money, as opposed to depositors'
money, so as to make a profit for itself. They may use a variety of strategies such
as index arbitrage, statistical arbitrage, merger arbitrage, fundamental analysis, volatility
arbitrage or global macro trading, much like a hedge fund. Many reporters and analysts
believe that large banks purposely leave ambiguous the amount of non-proprietary trading they
do versus the amount of proprietary trading they do, because it is felt that proprietary
trading is riskier and results in more volatile profits.
The relationships between trading and banking Banks are companies that assist other companies
in raising financial capital, transacting foreign currency exchange, and managing financial
risks. Trading has almost always been associated with large banks, however, because they are
often required to make a market to facilitate the services they provide.
For example, if General Store Co. sold stock with a bank, whoever first bought shares would
possibly have a hard time selling them to other individuals if people are not familiar
with the company. The investment bank agrees to buy the shares sold and look for a buyer.
This provides liquidity to the markets. The bank normally does not care about the fundamental,
intrinsic value of the shares, but only that it can sell them at a slightly higher price
than it could buy them. To do this, an investment bank employs traders. Over time these traders
began to devise different strategies within this system to earn even more profit independent
of providing client liquidity, and this is how proprietary trading was born.
The evolution of proprietary trading at banks has come to the point whereby banks employ
multiple desks of traders devoted solely to proprietary trading with the hopes of earning
added profits above that of market-making trading. These desks are often considered
internal hedge funds within the bank, performing in isolation away from client-flow traders.
Proprietary desks routinely have the highest value at risk among other desks at the bank.
Investment banks such as Goldman Sachs, Deutsche Bank, and the late Merrill Lynch are known
to earn a significant portion of their quarterly and annual profits through proprietary trading
efforts. The proprietary trading desk is kept separate,
by law, from knowledge about customer flow, so they cannot engage in the business of front-running
a customer's order. There often exists confusion between proprietary
positions held by market-making desks and desks specifically assigned the task of proprietary
trading. Because of financial regulations like Volcker
Rule in particular, major banks have spun off their prop trading desks or shut them
down all together. However, prop trading is not gone. It is carried out at specialized
prop trading firms and hedge funds. Some notable prop trading firms are Virtu Financial, Tower
Research Capital LLC, Jump Trading LLC, KCG Holdings, Inc., Traditum Group LLC, First
New York Securities and DRW Trading Group. The prop trading done at these prop trading
firms is usually highly technology driven, utilizing complex quantitative models and
algorithms. Arbitrage
One of the main strategies of trading, traditionally associated with banks, is arbitrage. In the
most basic sense, arbitrage is defined as taking advantage of a price discrepancy through
the purchase/sale of certain combinations of securities to lock in a profit.
Many people confuse arbitrage with what is essentially a normal investment. The difference
between arbitrage and a typical investment is the amount of reward: the risk in what
is known as arbitrage today is market neutral. From the moment all legs of an arbitrage trade
are executed, a profit is locked in. The trade will remain subject to various non-market
risks, such as settlement risk and other operational risks. Investment banks, which are often active
in many markets around the world, constantly watch for arbitrage opportunities.
One of the more notable areas of arbitrage, called risk arbitrage, evolved in the 1980s.
When a company plans to buy another company, often the price of a share in the capital
of the buyer falls and the price of a share in the capital of the purchased company rises.
When an investment bank believes a buyout is imminent, it often sells short the shares
of the buyer and buys the shares of the company being acquired.
Conflicts of interest in proprietary trading There are a number of ways in which proprietary
trading can create conflicts of interest between a trader's interests and those of its customers.
As investment banks are key figures in mergers and acquisitions, it is possible for traders
to use inside information to engage in merger arbitrage. Investment banks are required to
have a Chinese wall separating their trading and investment banking divisions; however,
in recent years, dating most recently back to the Enron scandal, these have come under
great scrutiny. One example of an alleged conflict of interest
can be found in charges brought by the Australian Securities and Investment Commission against
Citigroup in 2007. Famous trading banks and traders
Famous proprietary traders have included Steven A. Cohen, Daniel Och, Boaz Weinstein. Some
of the investment banks most historically associated with trading was Salomon Brothers
and Drexel Burnham Lambert, and currently Goldman Sachs. Nick Leeson took down Barings
Bank with unauthorized proprietary positions. Another trader, Brian Hunter, brought down
the hedge fund Amaranth Advisors when his massive positions in natural gas futures went
bad. Gender divide
Trading is a primarily male dominated occupation and women in finance tend to be paid less
than their male counterparts. Anne-Marie Baiynd believes that more women don't apply to proprietary
trading firms because of the general notion that this kind of career is not stable, confrontational,
and very friction based - the standard female psyche does not gravitate to these kinds of
roles. Following the recent financial crisis, more women started to take up trading though
finding women in the field seems to remain difficult.
Regulatory overhaul in the United States
See also Flow trading
References ^ staff. "President Obama Calls for New Restrictions
on Size and Scope of Financial Institutions to Rein in Excesses and Protect Taxpayers".
The White House. Retrieved 2013-05-03. ^ "Conflict of Interest Lessons From Financial
Services". 2005-02-22. Retrieved 2009-01-13. ^ "Citigroup challenges Australian commission's
conflict of interest ruling". ^ Belsky, Gary. "Why We Need More Female Traders
On Wall Street". Time. Retrieved 2013-05-02. ^ Kopecki, Dawn. "Women on Wall Street Fall
Further Behind". Bloomberg Businessweek. Retrieved 2013-05-02.
^ Bellafiore, Mike. One Good Trade: Inside the Highly Competitive World of Proprietary
Trading. Wiley Trading. ISBN 978-0470529409. ^ Lambert,Emily. "More Women Are Trading - Here's
Why". Forbes. Retrieved 2013-05-02. External links
http:www.cfo.com3004344?f=related http:www.trading-lab.comintroduction_proprietary_trading-t305.html
http:www.ft.coms44f593ee-06a7-11df-b426-00144feabdc0.html Proprietary trading: truth and fiction