Everything You Need To Know About Equities Trading: History, Industry Overview, My Experience And Advice
I first got the trading bug at 15 when I went to visit my cousin at the Chicago Mercantile Exchange. This place was the size of a football field filled with guys screaming and gesturing like I’d never seen in my life. The noise, the excitement, the money in the air – I couldn’t believe my eyes and ears.
These guys didn’t look like the sharp suits I was expecting, they looked like dock workers. Pit traders are blue collar guys who would have been driving a truck if they didn’t have a cousin who hooked them up with a job.
When I first met my cousins friends they’d drawn tits on their cards and put them around their desk mics to act as nipples.They’re a dying breed now but at one time the world’s equities were handled by huddled masses of men screaming and signaling million dollar orders at each other.
At 15 I only thought two things. One I couldn’t believe the government let these maniacs manage our monetary system. And two that I was going to be one of these guys. But it wasn’t until I was failing out of University that the plan began to take shape. And that plan was to become really rich.
With all the delusion of a 21 year old College dropout I set my sites on building a massive hedge fun. The way to get there I decided was to become a superstar trader. And so my first mission took shape. And like all missions thereafter I attacked it with single-minded dedication.
Soon enough I saw the owner of my soon-to-be firm on the financial news and on a whim I quit my job and went to go work for him for free. At 22 I joined the largest day trading company in the world to make the millions I believed were mine for the taking.
The game was simple – they fronted me the cash and in return I got to keep 40% of what I made. No salary, no benefits, no bullsh*t.
Like my hero before me, Jesse Livermore, I was determined to follow his footsteps in the modern day version of the bucket shop – the prop shop.
And so it began but it wasn’t pretty. In fact it was downright ugly. It took me a year before I became profitable but with the dogged determination I bring to everything I do I eventually became one of the most profitable traders in the company.
In July 2006 alone I did $127,000 in revenue and took home over $60,000. Not bad for a 24 year old with no education.
I had more money then I knew what to do with. All from playing a computer game in a place where guys smoked weed at lunch and drank at their desks. But before we get into how it all went down we first need to delve into what trading really is.
The History Of Equities Trading
Publicly Traded Companies
Equities trading is defined as the buying and selling of shares in publicly traded companies. The first exchange was officially opened in Belgium in 1531 but it wasn’t until the 1600’s when things got interesting.
The British, Dutch and French governments gave charters to the East India companies so that they could pillage India with the full confidence of the King behind them.
These companies became the first LLCs (Limited Liability Companies) offering joint stock to investors as well as dividends on the proceeds from successful voyages.
The success of the East India companies led to the emergence of the South Sea Company as well as many other fraudulent companies created by unscrupulous businessmen trying to cash in on the new game and in turn creating one of the first bubbles.
The Cyclical Nature Of The Markets
With the meager profits of the South Sea voyage the bubble burst and the first stock market crash was born. A pattern that’s continued ever since at the rate of about once per decade. Here are a few of the most recent crashes.
Panic of 1901
Panic of 1907
Wall Street Crash of 1929
Recession of 1937-1938
Flash Crash of 1962
Market Crash of 1973
Black Monday 1987
Friday the 13th Crash 1989
Black Wednesday 1992
Dot Com Crash 2000
Financial Crash 2007
The Emergence of Modern Trading
The facade of stability and respect your bank presents to you is just that, a facade. The nature of the beast is boom, bust and it always will be. With that said it’s still the least worst system we have.
The history of modern trading in the U.S. started on Wall Street where brokers would stand outside on the street yelling orders at each other.
Eventually they moved inside a building to continue yelling orders at each other forming the New York Stock Exchange – a privately owned company that facilitates daily trading. Over time the NASDAQ was born to handle stocks that the NYSE chose not to list.
Take note that both the creation of America’s money supply and its distribution to the capital markets are handled by private companies, namely the Federal Reserve and The New York Stock Exchange respectively.
As time went on the NASDAQ moved online completely and in 2006 the NYSE moved to a hybrid market mixing specialists in the pit with online order flow technology.
As the market evolved different types of traders began to emerge. This is important to note if you want to understand the capital markets because not all traders are created equal.
Types Of Traders
Hedge Fund Managers
A hedge fund in the simplest terms is a company that manages money for wealthy people. A hedge fund differs from a mutual fund in that it can take short positions and can use leverage that mutual funds can’t. Hedge fund managers are the biggest sharks in the ocean and their compensation can be in the billions.
Large hedge funds are run by market wizards like George Soros who like to take big gambles on large moves in the market or start revolutions in foreign countries and profit from the results.
A hedge fund is deemed by regulators to be riskier than a mutual fund so only accredited investors are allowed to invest. Accredited meaning rich and therefore assumed to not be retarded. The regulators prefer the retards to pile into high MER mutual funds.
Hedge funds are expected to return at least 20% a year and for their efforts get higher compensation compared with mutual funds. They’re also punished more harshly than mutual funds and a few down years is enough to sink even a successful fund.
A hedge fund manager and his senior portfolio managers will tend to make macro moves but will also carry a staff of intraday prop and quant traders. More on them below.
The larger banks employ a number of different types of traders, they have prop and quant guys who tend to be the biggest earners in the banking system. Due to the regulatory environment today many bank traders are actually just glorified order takers who don’t place directional bets. Instead they act more like middle men for the bank’s wealthy clients.
These are the worst traders on the planet. Companies like E-Trade who promote active trading accounts are no better than online casinos. Personal traders have no information, huge trading fees and very little money.
They are the sheep to be sheared. Warren Buffett’s billions have to come from someone and that money comes from the individual trader and the individual investor. These guys burn through their money quickly by paying high trading fees and not cutting their losses.
The market maker competes for order flow with other market makers and day traders. Once they get an order they immediately sell from their own inventory. If possible they try to profit on each transaction. The market maker takes the risk of holding a large number of shares and the responsibility of creating liquidity and an orderly market.
When it comes to markets like the NASDAQ each stock will have multiple market makers represented by one of the major banking houses – say Barclays PLC. The NYSE operates differently where the market is made by the specialist an employee of the NYSE corporation.
The specialist is completely responsible for maintaining an orderly market. In my day the specialist ruled with an iron and inefficient fist sometimes halting the stock for minutes at a time only to open 50 cents lower.
Quant (Quantitative) Traders
Quants or quantitative traders are guys with rocket scientist IQs who decided to make money instead of withering away in the obscurity of academia.
They generally work for hedge funds or banks building complex algorithms to arbitrage tiny price discrepancies. It’s guys like them who helped put guys like me out of business. At 33 I’m a dinosaur, these guys are the future. As Steven Goldstein puts it:
The traders who survive today will be those who can code
Brokers Aren’t Traders
Boiler Room, Wall Street, The Wolf Of Wall Street – these are movies about brokers not traders. Brokers, or advisors as they’re now called, are salesmen whose job it is to take as much of their client’s money as possible in commissions. Whether their clients make money on the deal is just a bonus.
When I told my family what I did for a living they thought I was a broker. Trading with faceless people on the internet was incomprehensible to them.
A prop shop is home to the proprietary equities trader, day trader or high frequency trader. You can find prop traders in banks, hedge funds and in prop shops. They usually work on 100% commission percentage going back to the firm for the use of their software, information and leverage.
Prop trading was my window to the market, the real market they don’t show you on CNBC. To understand how we made money we first need to get into the basics of day trading and how the company operated.
The Prop Shop
My company was originally founded by two guys who had a made a fortune in the early days of internet p*rn and figured day trading was going to be the next hot thing. The original model was that they would offer leverage, a trading platform and lower execution fees for guys who were looking to trade their own money – in return they would get a percentage of their profits.
After the dot-com bubble burst most of their guys went bust or had to get real jobs. So they pivoted and rebuilt the company as a franchised mctrading shop – the business model was brilliant.
For $100,000 and 50% of their profits anyone could open a branch. In return they got access to the company’s massive leverage, training, software and reduced trading fees. Instead of hiring only guys who had the money to play, the company could now hire every young kid off the street and make the branches responsible for his losses.
This was a great deal for guys like me, we got to keep between 40-60% of what we made and didn’t have to put any money up. By the time I got there they had close to a 100 branches worldwide. This place was a money making machine.
A typical prop shop, much like the bucket shops of old are outside of the traditional financial system. I worked out of head office directly which was housed in a dull, grey, nondescript office building filled mostly with call centers and the miserable slaves that work there.
Inside our office it was a different story – the place looked like a clown college. I’ll never forget my first day walking off the elevator – the walls were painted bright red, yellow and blue because the owner believed these were the most stimulating colors. Past the elevator was a foosball table and at least 50 trading desks – I was instantly mesmerized by all the action.
Compared to the grey death of my soul crushing corporate job this place was a paradise. On day one we were told the official company policy was to throw sh*t at the wall and see what sticks and that we were that sh*t. First we’d have to pass training class then we’d have to make $2000 a month in trader training.
Training class was three days. The most important things you learn in training are:
Theory means nothing
No one knows anything
Cut your losers quickly
Still some of the best advice I’ve received in trading and in life. We also learned the basics of day trading and how to make money in the markets starting with how to monitor the level 2 and read charts.
Level 2 and Charts
Stocks trade online on what’s called a level 2 using a bid and offer (ask) system where those who want to buy stock will put up a bid and those who want to sell stock will put up an offer. The level 2 will show all the available bids and offers for that stock.
Here you can see the level 2 for CDOI surrounded by a candlestick chart, this is a similar setup to what I would use. I’d usually have six or seven stocks set up like this across two monitors. I would set up one monitor for charts and the other one for the level 2’s of all the stocks I was monitoring that day.
Market Makers And ECNs
Next we learned how to read the market makers and use the ECNs. ECNS or Electronic Communication Networks are electronic systems that allow you to bypass the market maker for that particular stock.
We we’re doing so much business for these guys they would send their VPs over to wine and dine and dine us. The best part was watching the look on their faces when they realized we were just a bunch of punk kids.
Technical trading we learned is the attempt to predict market moves based on the reading of chart patterns and indicators. The most common chart pro traders use is the Japanese Candlestick Chart seen below.
The most common indicators are Bollinger bands, stochastics, fibonacci numbers, moving averages. None of these work on a consistent basis but a lot of traders will swear by them.
With that said I would use charts and certain indicators as benchmarks to see how a stock is trading that day and what it’s daily range is, this is especially useful for momentum style trading.
Fundamental analysis is the analysis of a stock based on its numbers as a business. For the long term value investor the balance sheet is the be all and end all. But for the day trader, we were taught, the balance sheet is all but useless with a few exceptions.
Many times we’d trade stocks where we didn’t even know what product they made, sometimes without even knowing the company name.
The exceptions to the rule is breaking news that hasn’t been factored into the stock price like:
Trial results (especially in pharma)
Any type of unexpected news, good or bad like the above will move markets so it was important to watch out these things.
High Frequency Momentum Trading
Momentum trading was the style that most guys were trained on, myself included. Momentum trading at its simplest is trading the market based on your feel of the momentum of the stock.
Most of the moves we were taught to make were small, 1 to 3 cents, and to average 300 to 400 of these microtrades a day. The aim to make quick profits based on the direction of a stock because momentum is much easier to forecast in the immediate term. We also learned how stocks moves and that every stock behaved differently:
The high volume/low priced stocks like Ford wouldn’t move much
The mid range/high volume stocks like Texas Instruments would have decent movement
The high priced/high volume stocks like Exxon had crazy movement and would rip your face off if you weren’t careful
We learned not to trade low volume stocks because there wasn’t much action which made it hard to get out of positions.
Credit or rebate trading was a method of trading we learned as a way to profit off the rebates offered by the ECNs for providing liquidity. Credit trading does not need to be profitable on paper, the majority of guys credit trading would make money on even trades being filled as they sat on the bid and offer while collecting rebates from the ECNs.
Of course every once in a while they would get run over and lose their week but overall it was a profitable strategy with a lower risk then momentum trading. There were guys in our office making six figures from making even trades all day.
Dark Pool Trading
The dark book or dark pool is an invisible market designed for institutional clients to unload a large position anonymously and without affecting the market. The position will usually be priced outside the market giving the buyer a reward above market rates.
In the early days of dark books (around 2005) if you happened to stumble across a dark pool this was an amazing arbitrage opportunity. One of our Israeli traders cleared a million in a year just arbing between dark pools and the market.
After passing training class I was ready for trader training. My first day of training I remember sitting down to set up my station only to hear Rammstein being blasted over the in-house P.A. system – this was my kind of place I thought as I smiled to myself.
Training was an unpaid, your job was to take the basic amount you learned in training and to go make money. You were given $10,000 of buying power to play with until you could earn $2,000 a month wherein you graduated to full time trader. Looking back I would say maybe 1 out of 200 guys made it through training.
There were two rules, no overnight positions and no holding trades past your shut down, both things would get you fired. Your shut down was the amount of money you were able to lose, for trainees that was $100 a day. This was to stop rookie traders from hemorrhaging money.
Training was supposed to take four months. If you couldn’t hit $2,000 by then you would usually quit or get fired. There must have been thousands of guys through the door and almost just as many leaving under just a few months, I was determined not to be one of them.
I figured I could graduate in less then two months because I was smarter than the rest of those guys – but I was wrong, dead wrong. In fact I ended up being the longest graduation in company history. It took me an entire year of working unpaid before I graduated to full time trader.
The only reason I didn’t get fired is because management liked me and knew how dedicated I was. After work I would go to the library and read everything I could on finance and trading until it closed at 10 pm. I went home every other day trying not to kick a hole in the wall but I never quit and my persistence and my persistence eventually paid off.
Full Time Trading
This was it, after a year of banging my head against the wall I was ready for the big show. The training wheels were off and it was time to get paid. The trading culture was insane much like the Chicago Mercantile pit that first sparked my interest in the game. The guys were young, aggressive and money hungry with an emphasis on young. 30 was ancient and 35 was non-existent.
Prop trading, especially high frequency leveraged scalping like what we did was a young man’s game. Much like e-athletes guys reflexes peak around 22. It was also not uncommon for the best traders to be guys who were good at video games, myself included.
Me and the other top traders filed off a corner for ourselves to do whatever we wanted which was usually blasting hip hop and talking sh*t. Everyone in our section could spit 3oo Bars And Running by the end of 2006.
I loved it. You earn what you keep and if you don’t earn you don’t get paid. No hr, no bonuses, no degrees just a pure meritocracy. It’s still the only job I ever liked. But that’s not to say it wasn’t always fun, it wasn’t. In fact every other day I was ready to kick a hole in the wall. Being a pro trader is the easiest way to get upset especially if you have a temper like I do.
When you go into work only to lose $5,000 grand within 5 minutes of the opening bell it can be tough on the psyche. Especially when you’re shut down and have to go home and think about what a retard you are.
Most traders are degenerate gamblers these guys would bet on 2 cockroaches climbing up a wall. I’ve never been a gambler though, I was in it purely for the money, not for the high. My mind was on consistent money for the next decade.
As traders we were technically not employees we were independent contractors. What this meant is that we could come and go as we pleased. The market opened at 9 but you could come in and leave whenever you wanted as technically we were independent contractors not employees. I missed a lot of days because I woke up at 1 and couldn’t be bothered to shower and shave for only a few hours of trading.
As long as you made money you could do what you whatever the f*ck you wanted and we did whatever the f*ck we wanted. The language you heard would make sailors blush. The place was an HR nightmare to say the least, that’s why we didn’t have an HR manager.
Before lunch at least 10% of the office went out to the courtyard to smoke weed. Trading high was fun because all the flashing colors on the level 2 became hypnotic.But it also meant that I would lose money. One day I lost two grand because I forgot to punch out of a trade, that was my last day of smoking weed at lunch.
Then there was the booze. Drinking at your desk wasn’t uncommon either. One illustrious colleague would polish off a bottle of wine at least a once a week. Drinking after work was a daily thing. And by after work I mean by 3 pm when the markets were starting to wind down. Many guys would go to the bar for lunch and not come back.
Like athletics or blogging most guys made no money, a small portion made a living wage and a tiny fraction made a fortune. Maybe 1 out of 10o graduated traders made actual money and by 2006 I was one of them.
Our top trader took home close to $1,000,000 in 2006. At the peak of my powers I had $3,000,000 in buying power and a daily shut down of $5,000. My best day I grossed $17,000 and took home $12,000 – making that kind of money so quickly was dizzying.
At one time it became easier to make the money then it was to deposit it. It took on average at least 30 minutes to cash a check including two tellers and a supervisor. The bank tellers couldn’t have been more suspicious when I walk in with backwards hat on to deposit a check of $60,000. I might as well have been carrying a duffel bag full of money.
The money didn’t really start to come until Someone Who Isn’t Me or anyone I know figured out how to spoof the market. This was a technique SWIM learned from watching market makers like Goldman Sachs on the NASDAQ manipulate the market by posting fake bids and fake offers.
This was at the time a grey area but is now thoroughly illegal despite still being done by every major bank and hedge fund. The way it worked is SWIM would gradually build a position in a thinly traded stock by buying up shares and posting bids behind them to make it seem like there was support for the movement.
SWIM would then continue to by up the offer and move his fake bids up. The idea was to create real demand for the stock. SWIM would then sell his remaining shares into the demand sometimes moving the stock as much as 75 cents. When executed perfectly it was a beautiful thing.
On a good run you could even sit on the offer and establish a short position before you pull your bids and whipsaw the stock back down. Sometimes on more volatile days this would even work on larger stocks. SWIM remembers making $4,000 on Verizon within the first few minutes of the opening bell by whipping the stock up and down 10 cents each way. Rarely has SWIM seen something so majestic in person.
With that said it didn’t always work out like that. When things went wrong they went very f*cking wrong. All it would take is for one big fish to call your bluff, buy out all your bids and put you down $50,000 in seconds. This happened to SWIM once. He was so shocked he did the only thing he knew how to, he closed his eyes and prayed. When he opened his eyes again 45 seconds later he was in a $2000 winner – those were the days.
For those of you guys questioning the morality of this stuff it was all going on between day traders. The old lady who buys the stock for her retirement is not going to be effected whatsoever if the stock fluctuates 10 cents in a minute because she’s going to be holding that stock for years.
The End Of My Run
In 2005/2006 the NYSE moved to a hybrid market, one relying much less on the specialist which completely altered the movement of all stocks. They hybrid market made the NYSE trade much like the NASDAQ making the stocks much harder to read and more susceptible to algo traders. The NYSE was my playground until then and this completely destroyed my strategy.
The exchange also decided to triple the fees for intraday traders like us knowing we were becoming a huge profit center for them which pretty much priced our style out of business. I went 6 months of not making money before I hung it up. I then spent the next 6 months at home trying to develop a system that would get me back in the game but it wasn’t meant to be.
What You Need To Know
1) No One Knows Anything
Absolutely no one knows what the f*ck they’re talking about. Even the best traders in the world are wrong half the time, they just punch out of losers quicker. That economist on CNBC has never placed a bet in his life. CNBC can talk about market news 24/7 and it’s all irrelevant.
The market is bigger then everyone including the biggest hedge fund managers. No one knows where it’s going and anybody can go broke any day of the year.
2) It’s A Zero Sum Game
Trading like checkers, tennis or poker is a net sum game. In a net sum game the winners winnings are provided by the loser. The stock market is not a wealth creation system it’s a wealth transfer system from the dumb money to the smart money.
3) The Monetary System Is A Giant House Of Cards
The entire world monetary system is an epic illusion fueled by trillions of dollars in non-existent money. Bears have been predicting the great crash for sometime and I don’t disagree. With that said, what we can’t predict is the timeline, it could be five years from now or 50 years from now. So far the government has been doing a great job at manipulating the money supply, buying out failing companies and postponing the inevitable.
4) Trading Is Gambling
Trading is gambling, you’re placing bets on the direction of the market, it is absolutely no different then a casino. I would use the words professional gambler and professional trader interchangeably. In fact most traders I worked with were degenerate gamblers. Many guys had online poker rooms up while they were trading.
5) The Markets Crash Every Decade
Boom and bust. That’s the cycle of the markets, it always has and always will be. Any time people start talking about how the old rules don’t apply anymore, like they were in the dot-com bubble, that means it’s usually close to the end. It’s amazing how people will invest their life savings without even looking at a 100 year S&P chart.
6) The Game Is Rigged
You’re competing in a zero sum game against the best, brightest and most connected people in the world. They have leverage, information, execution and connections you never will. From spoofing to front running to broker first calls the stock market doesn’t exist to create wealth it exists to transfer wealth, from you to them.
The market has become a highly manipulated gambling casino for the elite, where bank and hedge fund investors, high frequency traders, and the Fed’s massive injection of liquidity into the system have fueled a record-breaking, inflated, and unsustainable market.
7) The House Always Wins
The way to beat the market consistently is to own the exchange. High fees, poor execution, slippage. All these things work against you. Even the biggest and best guys still go broke on occasion. There is no secret that wall street doesn’t want you know. There is no system of consistent profitability – that is unless you own the house where everyone spends their money.
Why You Shouldn’t Trade
This is not the business to be in if you want to make sustainable cash for the rest of your life. In fact it’s not even a business, it’s gambling pure and simple. Now I know you might know some success stories or that guy on youtube who is making cash but check back with them in a decade or even three decades. Here are seven reasons you shouldn’t trade:
1) Trading Skills are non transferable
After my run at trading I was unemployable, banks weren’t looking for guys like me, they were looking for quants with Steven Hawking IQs. Maybe I could have got a back office bank job making $70,000 like some of my buddies did but the thought of getting a real job made me want to shoot myself. At the end of the day I spent three years learning skills with zero market value outside of trading.
2) NO OPM
Without OPM or other people’s money it’s very hard to get rich. The only reason I had real money was because I had $3,000,000 in buying power. Even if you can match George Soros’ run of 20% a year for the next 30 years (which you can’t) it’s still going to be 30 years before you’re rich. To get rich in the next 10 you need either a business with huge margins or access to a ton of other people’s money. George Soros didn’t get rich from trading, he got rich from other people’s money. He got other people’s money from selling a superior product – a 20% yearly ROI.
3) The Odds Of Success Are Abysmal
999 out of 1000 people will fail at trading and those are professionals. The average guy has no business trading because he has no access to information, slow execution, high trading fees and is not treating trading as a full time job.
5) You’re Competing With The Smartest Minds In The World
You’re out there competing with George Soros and Paul Tudor Jones. You are the guys putting up the money to the table that makes them billionaires. They have every edge in the world and you have none.
6) You Have No Edge
Not only are you gambling against the best in the world without an edge you have a distinct disadvantage emotionally. Two years of having my brains beat out of me for the slightest mistake instilled a massive amount of discipline in my young mind.
This is not something you can learn from a book, the stress is brutal. The discipline and ability to handle pressure is something you can only learn from experience and that experience costs a lot of money. Money that will put you out of business trying to trade your own account.
7) Your Lifespan Is Tiny
No one I know is still trading. Not a single, solitary soul. Much like a pro football player the average trader has a shelf life of three years. The difference is the football player leaves with his money. For guys trading their own accounts many times they leave with nothing or worse. I got lucky because I left with my cash. My cousin the pit trader wasn’t so lucky, he went broke in his 50’s selling options and he’d been a pro for 30 years.
Exceptions To The Rule
As always there are a few exceptions to the rule. I loved my time in the trenches but I was the exception to the rule because I was in the right place at the right time. The opportunities I had don’t exist much anymore but I would allow for two exceptions for guys who want to give it a shot:
Exception # 1
You’re young, you live at home, you’re willing to risk a year in your prime and you’ve found a prop shop that lets you trade with no money like I did. Unfortunately those opportunities don’t seem to exist anymore, I was in the right place at the right time. Most prop shops require cash down and that’s just not the right move for you.
The other exception is if you can get a job at a prop desk of a hedge fund or institution coming straight out of school. These guys have the execution, the know how, the leverage and the information edge you need to actually make money. Generally they’re going to be looking for an ivy league degree or equivalent in economics, finance or rocket science (quant majors). If you have one of these it’s worth a shot.
My mandate at RLD is the greatest good for the greatest amount of guys and trading is not a good move for the vast majority of guys. I loved my time in the trenches and actually left the game with a lot of money, but I was lucky and I was in the right place at the right time.
With that said if you’re truly committed and trading is your mission then don’t let me stop you. I just want you to have all the information available to make and informed adult decision. And if you can make it happen in trading I’ll be the first one to shake your hand.