Prop trading is a real fad, but what was it like before the current boom? Let’s see together how prop trading companies were born
Prop trading companies are now very famous all over the world, yet this phenomenon has seen a real boom only in recent years, since everything has become more telematic, including the management of money of companies that they engage in proprietary trading. But what was the prop trading industry like before this fad was born? Which were the most important companies and what specifically did they do? Talking to former prop-traders, or rather, tarders who have operated in real trading houses, we can notice abysmal differences with what is now considered "Prop Trading".
To date, real challenges are being built, which see winners who will receive managed capital as a "prize", a capital which will then have to be managed by the trader to generate profits which will generally be "split" between the prop trading company and the trader himself. In principle it works like the old prop trading houses, but the differences are absolutely abysmal and we will see them shortly in this article where we could notice all the differences, the pros and cons of the current proprietary trading with the old concept of prop trading houses .
The old prop trading houses, a bit of history
Early 2000s. We are close to the bursting of the real estate bubble that led to the great subprime mortgage crisis and in those years the strongest traders of the global financial markets, first of all London and New York, were inside the banks, in separate rooms with respect to the classic trading floor, a sort of space where the brightest minds could give free rein to their potential as risk managers. These individuals were what were defined as the “prop traders” of a bank, i.e. traders who had capital chosen by the bank and with which they could make investments and trade as they saw fit, without many constraints, such was the reliability of their work. In practice, they were real superstars in the sector and the banks competed for them with salaries and bonuses similar only to those of a top-level sportsman, with the advantage of having however a great deal of privacy in comparison.
Then, 2008 arrives, the earthquake that shook the world financially and the banks found themselves cutting jobs and tightening their operations, as a result of the deleveraging process that affected the entire financial system. There was enough money left to run the bank’s normal business, certainly there was no free money available to the prop traders.
Thus there is a brain drain from the banks and here many of them begin to look for their place within the hedge funds, the family offices and within some companies that they manage their own capital with a hardware infrastructure similar to that of an investment bank, precisely, the prop trading houses.
It so happens that some traders broke a deal, having decided to open structures where they could make available operating desks similar to those of institutional traders and train new traders to obtain even more profit. The hardware was made available by the prop trading house, as well as the ultra-fast connections, the various instant information services, as well as the starting capital, only other traders were missing to train.
What a prop trading house offered
The point of reference for the prop trading houses was certainly London, the financial center of excellence for the European continent, but other European cities for prop trading, such as for example Amsterdam, could not be excluded. Basically in the prop trading houses there were rooms with desks where traders could operate as they wished, on the markets they wanted, obviously with the active supervision of the company’s managers.
Each desk was equipped with a Bloomberg or Reuters terminal, terminals with annual costs certainly not accessible to everyone. The connection is what is defined as Colt, i.e. an ultra-fast and very stable connection even in exceptional cases, connected directly to the reference financial market. The real-time information services, what were once called "squawk boxes" (not to be confused with bank squawk boxes) were active on all desks and provided real-time information, strictly by voice, on outgoing macro data , an excellent tool for traders who could not afford to take their eyes off the trading book.
Usually, the company’s guest trader paid a monthly fee for the workstation rental with prices that usually started from £2500 and up.
Training and placement
After a careful study of the curriculum, tests of a mathematical-statistical nature and of logic, including a English test, the trader could have access to a training course done by the owners of the company, ex bank prop traders. The process involved, after sending the curriculum, payment for the course and placement within a trading desk.
After a "demo" period, it was possible to switch to real capital which consisted of several tens of thousands of pounds and the reference markets were usually those of futures, a market favored by most of these companies.
Approximately 40% of the traders who were trained became profitable so as to have full operational desks and which guaranteed the coverage of the costs of the structure and the distribution of the company’s capital for each trader. However, traders had limits in managing capital, including the maximum losses allowed beyond which the desk closed its operations for the day.
At the beginning, after the demo period, the trader was initially required to manage the capital of the company with a recognition of the profit for the trader equal to 10% of the total profit. If the trader proved to have talent, or rather, demonstrated a certain "consistency" then the split rose, first to 20%, then to 50% up to 70% for the best traders. Earnings could be really high and many traders could literally move the bid-asks of the order books with a click, given the number of contracts that were usually traded.
The differences with today’s prop trading
Surely the first difference is in the selection of the candidate trader. In the old companies it was accessed by examining a curriculum, tests and then you could access training. Today it’s enough to pay, and here we are in a challenge where (short-term) results count.
The second lies in the hardware available to the trader. Hardly a trader who accesses prop trading today has a Bloomberg or Reuters terminal at his disposal to trade, on the contrary, everything is in his own hands, from the internet connection to the hardware, thanks to technological progress and the possibility of having a connection anyway good even at affordable prices but nowhere near the reliability of a Colt that has direct access to the markets.
The third difference is that physical prop trading had traders of an advanced technical level, with an excellent resume and an excellent career behind them, at the head of the company, which is not the case today.
Original article published on Money.it Italy 2023-04-29 15:41:00. Original title: Prop Trading, come funzionava prima del boom attuale
