Original subtitles

in this video i'm going to teach you exactly what wall street traders do and

they make money having worked as a trader myself for the past two years my

is mert and i'm a quant trader i've worked at two different hedge funds now

currently working at high frequency trading firm and this is a video i wish

existed when i was trying to break into the industry so let's get started so

we'll be covering three different types of traders across the street first we'll

be covering hedge fund traders then we'll be covering high frequency traders

then finally we'll be covering investment bank traders because to be

honest with you all traders across these firms do very different roles and

different ways in which they make money so out of the three I have experience

having worked at a hedge fund and now currently working at a high -frequency

trading firm the only one which I don't have an experience in but I work very

closely with is investment bank traders across the board they all do very

different things and how they make money we're gonna break exactly what they do

in full detail let's start with hedge fund traders now this is the one which i

think surprises most people to be completely honest most people think

traders are the people who actually make the shots and guess where a stock or

whatever they trade goes up down etc etc but that's actually not true the

traders at a hedge fund are not the people who actually generate P &L. The

majority of the time when you hear the term trader at a hedge fund it usually

means execution trader which is very different compared to the other two

categories. In fact we're going to break down traders into two categories P &L

generating traders and not P &L generating traders.

Obviously it's great and we're going to talk in detail on what that actually

means. In a hedge fund structure the way it works is you usually have a chief

investment officer that's at the top. This is for the actual investment side

the firm so not middle office and back office which is like ops etc in front

office you usually have a chief investment officer and then you would

that you'd have a bunch of portfolio managers and then finally at the bottom

you'd have investment analysts and this is basically the team that generates P

&L if it's a large firm you might have senior portfolio managers junior

portfolio managers and same with analysts you might have senior analysts

junior analysts etc that's the P &L generating side of a hedge fund in the

office you would also have the traders which are responsible for execution

the term execution trader sometimes they're called trader or execution

but they're responsible for actually executing the trades which the portfolio

manager and the analyst decides that they want to do so I'm going to use a

short equity fund as an example. In a long short equity fund you would have

portfolio manager who has a portfolio of stocks that they go long and short in

very basic terms.

You'd have the investment analyst provide support.

This would be through doing

financial modeling, research, going on to conference calls, and all the grunt

work that the portfolio manager doesn't do. Then the portfolio manager would

make a decision. In that portfolio, they want to add, let's say, a thousand

stocks of Apple.

When they want to buy a thousand stocks of Apple, the portfolio manager will

internally ask the execution trader to execute that order on their behalf, on

their book. And when I say book, I'm talking about portfolio basically then

execution trader would say to the portfolio manager do you need a specific

of order meaning do you need me to execute this throughout the day which

the trader would have complete freedom into when they actually execute the

or they would say the portfolio manager might say can you execute this as soon

as possible which would mean you have to get it done now or they could say don't

execute it now but execute on the auction which is at the end of the day

the stock market goes into auction and then it's the execution traders

responsibility to execute that trade at the best price.

So the execution trader would be trading electronically voice through Bloomberg

etc with the sell side traders so investment bank traders for example

with a thousand shares of Apple

The execution trader will be trying to get the best price. If they have

freedom, they'll be calling up Goldman Sachs, JP Morgan, etc.

to try and get the best price.

And one of the key elements of their role is to keep that relationship with

different banks.

So hedge funds are clients of investment banks.

And hedge funds are buy -side firms.

So when they want to buy a product like Apple, they're trying to make money with

a prediction.

portfolio managers role is to generate P &L is to find alpha to find where the

Delta of that instrument is going to go the execution trader is then trying to

do that at the best price and then the hedge funders are in general is trying

make money through Delta trying to predict alpha and then on the other side

have the investment bank let's say the execution trader found that the best

price was going to be with Goldman Sachs The trade on the other side, this would

be the sales trade on the other side, will then execute that order and then

trade it off.

So let's explain that. Investment bank traders are market making.

They're not market taking. Before we talk about investment bank traders,

explain what is a market maker and what is a market taker. Because there are

very different types of orders and responsibilities in a healthy market.

I'm sure you hear that term everywhere. But what does that actually mean?

in this example the hedge fund is the market taker means when you have an

book i'll put up somewhere here you have a bunch of levels where orders are

going into there is no single price there is lots of bids and lots of offers

hedge fund is taking liquidity away from the book by buying the asset now on the

other side the investment bank trader is actually creating the market and the

way they do that is by putting maker orders in the exchange or on the order

the investment bank trader is constantly buying and selling based on their fair

value of that instrument so the investment bank takes on that risk and

say risk it means owning something meaning if it moves you make or lose

the investment bank takes on the risk using their balance sheet and then

it off so they hedge off that risk so in this case if the hedge fund buys that

apple stock it means that the investment bank goes short for that trade

which means the investment bank then has to hedge that short risk by buying

apple stock does that make sense So to recap, in an order book, you have a

of levels. When you take liquidity away, your aim to make money is to guess

where if it's going to go up. So if I buy something, I'm actually willing to

for it. So I pay a little bit of spread to buy that because I think it's going

to go higher or lower, respectively.

If I'm a maker, I am constantly quoting across the order book at different

levels.

to lots of clients.

And the idea is you make money from the spread, from the bid -offer spread that

you're providing. The main value that an investment bank brings to Wall Street

is liquidity provision.

They buy and sell. Because if they didn't, the prices would be volatile.

And the more amount of liquidity there is, it means that the price of an asset

converges into a fair price.

So an investment bank trader makes money on the spread they do not guess if it's

going to go up or down the hedge fund on the other side makes money from trying

to predict whether something's price goes up or down however that's not the

responsibility of the trader that's the responsibility of the portfolio manager

that being said some hedge funds do allocate funds to traders to trade and

money etc but usually when you hear the term trader at a hedge fund it means an

execution trader but on the investment bank the trader is responsible for the p

l however small caveat on the investment banks they do sometimes allocate funds

for proprietary trading directional bets as well and then finally high frequency

firms where do they sit high frequency trading firms and proprietary trading

funds fall into loose categories they do a lot of different things so A lot of

the high -frequency trading firms, which you know, whether it's like Jane

Street, Flow Traders, etc., they're market makers.

They also do have some proprietary trading as well. So they do take

bets into whether something's going to go up, down.

And they trade at very, very fast speeds.

However, a lot of high -frequency trading firms are market makers, similar

investment banks.

their traders are actually responsible for the P &L. And a lot of the

responsibility of a high -frequency trader is monitoring algorithms.

What does that look like? In a high -frequency firm, similar to an

bank, the trades are done algorithmically. Well, all the trades

algorithmically. But the trader's responsibility is, if they're market

is to sit delta neutral.

Again, they're not trying to predict if the price of something goes up or down.

provide liquidity to the market they quote at different levels they they

constantly quote on exchanges they might have an OTC franchise that means they

have clients that they trade with them basically the firm becomes an exchange i

could do more detail in what that looks like but basically their clients rely on

them basically willing to buy and sell the best way to imagine that is when you

go to a kiosk at an airport they're always willing to exchange your euros

sterling to knock etc and the kiosk always makes money right well you get a

little bit less money and the reason for that is they make markets they're

willing to buy at their given price at all times and that's the value that high

frequency firms and investment banks bring to wall street they provide

across the order books they they give the people who want to trade instruments

liquidity so they can trade at a fairer value in fact they do a lot of things so

some high frequency firms are simply proprietary trading firms whilst others

just market makers and they deal with very very low latency trading and one

way liquidity providers make money is actually through rebate so exchanges

actually pay liquidity providers like high frequency firms to actually make

market because making market could be costly because the idea is you are

willing to buy and sell just you pick the price so an exchange is only as good

as how liquid it is so exchanges will pay money for liquidity providers to

actually quote on their exchange so you can think of this as the exchange will

pay liquidity providers and the liquidity providers might lose money by

on their exchange but then they get paid through the exchange for a rebate if

you've enjoyed this video and learned something please drop a like if you have

any specific questions and want me to do a detailed video in any of the stuff

that i talked about today please drop a comment and i'll make sure to cover in

the coming videos