Traders directly participate in the financial markets through trading financial securities on behalf of clients. However, traders do not usually have direct contact with clients. Instead, they tend to deal with members of the bank’s Sales team, who act as intermediaries. They aim to generate profit through taking advantage of securities’ price movements in the market that occur as a result of fluctuations in supply and demand. To help predict where and when these price movements will occur, traders consider: commercial news and announcements (for instance, the imposition of new regulation); global events that could affect the supply and demand of a product (for instance an oil spill); historical price patters; and general market trends.
The role of traders is essential as they generate liquidity in the markets, meaning that they act as a channel through which investors can buy or sell their assets. Different teams usually exist to trade different assets such as equities, fixed income securities, commodities, currencies (FX) and derivatives. Traders in investment banks are known as market-makers, as they help to determine the prices at which assets can be bought or sold through influencing levels of supply and demand. Traders are required to quote their position in a market if they are asked.
Even though traders may work as a team and share similar goals, trading can be a very individualistic role as traders are measured (and to some extent remunerated) based upon their personal performance, as set out in their Profit and Loss (P&L) account. Traders are expected to make quick, informed decisions; have strong analytical skills; and be proficient at arithmetic. They must also have comprehensive knowledge of the markets in order to manage risk and generate profits.
There are a number of ways in which a trader can manage risk. This is commonly achieved by hedging against market risk. Hedging against market risk involves traders buying securities (meaning that they profit if the price of the securities increases), but hedging their position by simultaneously making investments that will generate a profit if the entire market drops (which would decrease the value of the stock initially purchased). For instance, investors may purchase shares in Company A, whilst simultaneously making an investment that will give rise to profits if the overall market in which Company A operates falls.
- Principal Trading: involves traders trading directly with clients, either selling securities that they already own to clients, or purchasing securities that are owned by clients.
- Agency Trading: involves clients transferring capital to a bank, which is then traded by the bank on the client’s behalf.
- Market-making: traders quote the prices at which clients can buy or sell, based upon general trends in the market and their own opinion as to how the market is likely to change. The price at which trades are executed sets a general trend in the market for the prices of particular assets. Prices then fluctuate depending on the number of people buying or selling the assets. The role of traders in helping to determine these prices accordingly gave rise to their description as ‘market-makers’.
- Profit and Loss Account: displays the net amount of money a trader has made or lost whilst trading.
- Shorting: Securities Lending (or Loan) desks will pay investors (typically large institutional investors) to borrow securities owned by the investors. These investors require collateral as protection in case the desk fails to return the securities on time when they are recalled (by the institutional investors). Traders can then access the borrowed securities and sell them either on their own accord (to generate profit) or on behalf of clients (and receive a commission) in the belief that they will be able to repurchase the securities at a later stage, at a cheaper price, in order to then return the securities to the investors from which they were borrowed. Investors may choose to lend stock to Securities Lending desks in such a manner if they wish to generate additional cash without having to actually sell their stock.
- Going Long: buying a security in the hope that the value will increase.
- Bid – Offer Spread: traders will quote a price at which a security can be bought and a price at which a security can be sold. The difference between these two prices is known as the bid-offer spread and this can determine a trader’s profit margin. The liquidity of securities can affect their bid-offer spread.
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By Jake Schogger - City Career Series