As a trader, there’s an important lesson to learn early on, which is that trading losses are part and parcel of playing the game.
They are unavoidable, since no-one can predict the markets all the time and no-one can win on every single trade. In fact, many traders have found success by being right just 30-40% of the time.
So if losing trades are to be expected, why then, do we hear reports of certain investment banks going whole quarters without recording even one losing day?
You read that correctly.
In the article linked above is a news story of how Goldman Sachs traders made money on every single trading day of the first quarter in 2010. That’s 63 days straight without a loss. And more than $100 million in net revenue was made on over half of those days.
Such impressive statistics are not unusual either.
So How does Goldman Sachs do it?
One thing you must understand is the difference between sales or execution type trading and proprietary or directional trading.
You see, there’s a reason why big investment banks like Goldman Sachs are able to report incredible trading quarters. And that’s because they’re primarily referring to sales or execution trading, or market making, which is what makes up the bulk of Goldman Sachs revenue.
It basically works like this. Wealthy clients and companies call up Goldmans trading desk whenever they want to invest in a stock or bond or some other security. Goldman Sachs traders then buy that security direct from the exchange, at interbank rates, and sell back to the customer with a tiny commission or spread added on top.
That allows Goldmans to pocket the spread and make what is effectively a risk-free profit. Because if they trade quickly there is very little chance of them losing money on the trade. And for large orders, the profit from the commission can be quite substantial.
So that’s basically how all investment banks work. They are simply middle men, facilitators to the exchange, and that’s how they can go many weeks without having a loss.
What do you want to pay?
It’s just like if you ring me up wanting to buy Apple shares. I buy them from the exchange at $99.50 per share and sell them to you for $100 a share. So I make a very quick and easy $0.50 profit on each share.
There is a bit of a problem, though. Because many people don’t realise that this is how the investment banks operate. Many assume that investment banks make their money through speculative trades and by taking risk. And many think that it shows the industry must be corrupt.
But if you know how execution traders actually do their jobs it begins to make a lot more sense.
Working in execution
So, if you get a sell side job at Goldman Sachs – or any investment bank – you’re not really trading as such. Not how most people perceive it anyway. You’re simply responding to phone calls from clients and then making a trade according to their requirements.
You’ll probably be monitoring volume and price movements in order to try and get the best execution possible but there’s very little actual risk involved.
Of course, this isn’t to say that execution trading is a bad job. It can pay very well and can lead to better things so it’s definitely a good route to pursue for many.
Thank You For Reading
Joe Marwood is an independent trader and the founder of Decoding Markets. He worked as a professional futures trader and has a passion for investing and building mechanical trading strategies. If you are interested in more quantitative trading strategies, investing ideas and tutorials make sure to check out our program Marwood Research.
This post expresses the opinions of the writer and is for information, entertainment purposes only. Joe Marwood is not a registered financial advisor or certified analyst. The reader agrees to assume all risk resulting from the application of any of the information provided. Past performance is not a reliable indicator of future returns and financial trading is full of risk. Please read the Full disclaimer.