Trading: Lower Spreads, Less Jobs? Think Again...
The dramatic depictions of the Wolf of Wall Street, Margin Call, and Wall Street, just to name a few, embody the public’s idea of financial institutions: rowdy trading floors with billions of equity shares being traded every day. Trading’s dominance on Wall Street masks many of the even more lucrative aspects of investment banks such as advisory services that generate mountains of fees, equity research, capital markets, private banks, and lending services for the Citigroups and JP Morgan Chases of the world. Prospective traders are warned about the growing robotization in trading that reduce spreads --- most notably from people outside trading. The Street saw Goldman Sachs replace 600 traders with 200 robots in 2017. The world has seen many cardboard boxes filled with personal belongings leaving Deutsche in London this past summer. Whispers of job cuts have filled the air. Nevertheless, traders are the greatest innovators. They’ve evolved from barter to Bloomberg. The world fails to recognize that traders will always exist because they are some of the smartest, most creative people in the world with an unlimited appetite for success and competition.
As a millennial who frequented the Office on Netflix, I cannot help but compare trading in the 21st century to the Michael Scott Paper Company. For those not familiar with Steve Carrell and Greg Daniel’s magic, the Michael Scott Paper Company is a newly created firm lacking sufficient capital to move forward. The new firm is run by Steve Carrell’s character that directly competes with his old firm. One of the great lines from the episode is Carrell childishly stating to his former boss that even if his new company fails, he will just keep creating more and more companies that cut into Dunder Mifflin’s, his old firm, bottom line. This analogy is important because it illustrates that traders will keep creating products that exploit an inefficiency in the market. Computerization will eventually catch up to the product, diminish the trader’s duties, increase the volume, reduce the spread, but then lead traders to innovating another product. If you ask a four-year-old, your grandma, or a person on the street what a mortgage backed security (fixed income product) is, and its significance from its origination at Salomon Brother’s to today, they most likely will give a reasonable, yet insufficient answer. Who would ever think that such a popular product originates with investors wanting risk in the housing market? With millions of other markets in the world, and asymmetric information, albeit less of it, what’s going to be the next big product? Traders will produce it.
You most definitely have heard the talking heads at CNBC say that the bottom lines of trading services have been reduced. There are 1980’s trading floor veterans who will say don’t go into trading because it’s a dying industry. Remember how you make big money: betting and winning against the herd. Who’s to say that there’s never going to be another revolutionary product that all investors want their hands on? You can either get to the party first, stand awkwardly asking when others are coming, then the party could turn into a Project X styled banger. Alternatively, you can arrive halfway through and get turned away at the door. Or you may not even show up at all and miss out on the best party of the year. It’s your choice where to go, but are you really going to miss the best party of the year because other people say it’s not going to be good? You could reason that these houses are known to throw great parties and are completely undervalued now by people on the outside. Trading, in this regard, is the house that was remodeled, redecorated, and recarpeted since 2008. Changing the structure of this house doesn’t permanently eliminate the smells and the experiences that previously occurred. Quite the opposite actually. The potential of that great party again is just around the corner. And who’s coming to the party? The smartest people around. Isn’t that what investment is all about? Find the ten-bagger the herd calls a piece of trash.
Trading isn’t going away. Michael Lewis’s Moneyball showed how the A’s changed baseball. The A’s didn’t create a new sport; they created a new way to win. Trading, just like the rest of the world, is constantly evolving. Smaller spreads are killing trading? Look at JP and Goldman --- both have growing trading revenue for the year. Let me know the next time hedge fund A trades 100k shares of AAPL to hedge fund B. They can’t. They need a license. The structure to buy and sell securities creates a need for licensed traders. Therefore, AI and electronic trading will not usurp all power from traders. Traders, like they always do, are going to propel themselves to the top through innovation.
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