3 lessons from the trading floor

This is my first article on YX Insights. If you're reading this, you're likely one of the earliest readers. I really appreciate your support.

I'm thrilled to have you join me on this journey as we dissect what’s happening in the US economy as well as the investment / trading opportunities in equities.

As a university student, I pursued my BSc in Government and Economics and my MSc in Real Estate Economics at the London School of Economics.For those outside the UK, LSE is basically where half of the UK’s investment bankers and traders are manufactured every year.

In my first job, I trained to become a Chartered Accountant (ACA) while auditing the trading desks at a UK investment bank. Even though I collected a prize for the best performing ACA candidate in London, I knew I would never become an actual accountant.

Luckily, I was able to I make my way onto the actual trading floor. The desk I joined had a long and fancy name - the FX Swaps and Short Term Interest Rates Trading (STIRT) Desk. You might recognise this desk from Gary Stevenson's recent book, "The Trading Game" (a highly recommended read). It sits across Fixed Income and Currencies.

Job on the trading desk entailed borrowing or lending one currency against another. I was the primary dealer for USDJPY, USDCAD, AUDUSD, NZDUSD swaps and Canadian interest rate products in London.

As a market-maker, the name of the game is to extract bid-offer spreads in the prices we quoted (this could be an FX swap or interest rate swap), while hedging profiting from the movements in either currency’s interest rates or the cross currency basis (XCCY). Cross currency basis is basically the difference between the theoretical interest rate parity and the implied USD premium / discount in the FX lending market.

Life on the trading floor was hectic. I was often dealing with 5-6 price requests at once, juggling between 4-5 trading books or products. We took on, monitored, and hedged risks every minute. This meant I spent every waking hour either thinking, speaking, or reading about interest rates. The Fed was a huge part of it.

Let me share some of the key learnings here.

1. The trading floor is a jungle. So are markets.

It could be as simple as a surprising one-line comment by Powell. Or an important piece of data like the non-farm payrolls.

The volume in the room would suddenly explode, as if a predator just got spotted in the jungle. All the animals would start to chirp, run, or climb. Price spreads would widen by 10x and not resume for minutes. You could feel the volatility spike without even looking at the screen.

Whether a threat is real or not, one should always be on their feet. The market can and will grab onto whatever it is and reprice the entire yield curve. Bad prices absolutely get picked on.

The market is a big jungle - fragmented, sometimes frenzied, but ultimately everyone marks their own nests and corners. Rarely is someone so dominant that they could move markets across every asset class or even products. The big hedge funds that you read on Bloomberg have only a fraction of the money managed by the quieter, benign real money funds.

Rarely can a single winning strategy lasts. It’s only a matter of time before others realise the trade and rush in. Like a pack of hyenas spotting a lone deer.

There is a lot of noise and opportunities. The market is in a constant flux. Equilibriums are short-lived. Markets are not, and cannot be, efficient. This is because they are played by humans. And humans have emotions. Fundamentals change much slower than price action.

Therefore, it’s the most adaptive player that wins in the long run, rather than a particular set of strategies. Many strategies can work really well for a while, and then ruthlessly blow up in your face. A lot of hedge funds bust because of this.

2. Bigger trading books (or budgets/ portfolios) make more in absolute dollar.

Sounds obvious right? Let me unpack it a bit more.

Some trading desks manage much bigger risks (and therefore P&Ls) than others, such as the USD Swaps, EUR Swaps, and Sterling Swaps desks. Their markets are bigger and more liquid than other products.

How someone lands themselves on one of these desks is part skill, part luck, and part dark art (aka. politics). A graduate can impress a trader on these desks early, or later in life, one could be racing fancy cars with the trading heads on weekends to get the leg up in the office (not joking).

A trader who makes $100m for the bank with the biggest client flow and risk limit is not necessarily 10x more skilled than a trader who makes $10m. In real life, the $100m trader might even be a worse trader, because they’ve become lazy. They don’t need to grind as much to make the extra dollar. But the difference in their year end bonuses can be enormous.

The size of the book / portfolio / capital can overcompensate for one’s lack of trading skills.

This has two important implications for how we should view trading and markets. Just because a “big player” or a “whale” did a certain trade, it doesn’t mean it’s a good trade. Their motivation is very different to yours. The same goes for when you read about Berkshire Hathaway or ARK’s latest investments.

Secondly, you can afford to take less risk if you already have a meaningful amount of capital due to your lucrative career in other professions. Many people like memecoins because they think they can 100x their $10k stake and become an overnight millionaire. But if you already have a lot of money saved up in your retirement account, you don’t need to risk it all. You only need to take small, sensible risks to gain the comfortable income stream you need. S&P500 helps you get 10% return on average in the long run without any work.

3. You don’t need a PhD in quantum physics to be a good trader.

It does help to be technical, meaning that you understand the fundamentals of the products you trade. It actually does not take as much as you think to gain an edge.

Even in the institutional world, a lot of people have no idea how their products should be properly priced. I’m talking about people who throw around billions of dollars daily in trade volumes. Just having a proper framework of evaluating the right relative prices and trade ideas can get you very far.

But being technical alone is not enough. In fact, many highly intelligent people are poor at taking risks. They either don’t trust their instincts or let fear rule them. This means they get in too late on a winning idea or exit too late on a losing one.

The best traders combine their technical ability with a healthy risk taking appetite and a strong mentality under pressure. When the tides turn against them, they not only cut losses but also quickly press on the other side.

And of course, they are absolutely obsessed by markets. I had a very savvy colleague who, after a candlelit dinner with wife on the first day of their honeymoon in Bora Bora, eagerly messaged me to place a new trade for him. “You must be having a lovely time,” I replied.

Note that point 3 does not contradict with point 2. In point 2, you just don’t need to be a good trader if you already sit on a lot of capital.

Why I am starting this newsletter

I initially left trading to pursue entrepreneurship. My co-founder and I have created a fun mobile app, Plantwise, that reached the top 20 in many App Stores around Europe.

While working on Plantwise, I began writing about the US Macro and individual stocks for Cestrian Capital Research on Seeking Alpha on weekends. Before I know it, it’s been 4 years and 100 pieces of writing. I have been the main commentator on the FOMC for Seeking Alpha News for more than two years.

I now want to step up the game and provide detailed, thoughtful insights on both the US Macro and publicly listed companies to a much wider audience.

I analyse markets from first principles. This means huge amount of in-depth work on the key economic data, company fundamentals, and price analyses. What you read from YX Insights will the culmination of years of learnings from my experience as a trader, Chartered Accountant, and a startup entrepreneur.

My hope is that my analysis will ignite a spark in you, providing a more complete picture of the market.

Thank you for joining me on this journey. Feel free to share any suggestions or comments, either directly through email or in the comment section. Your support is greatly appreciated.

Yimin, 14 June 2024