As far as books for Wall Street professionals go, there have been several written about investment banking. There are hundreds devoted to trading techniques. Hundreds more have been written about investing. There are even a number of books covering the securities industry’s back-office operations. But there are very few that take the reader onto the trading floor.
Alan Rubenfeld did it with his collection of essays titled "The Super Traders." Professor Larry Harris did it with his seminal "Trading & Exchanges." Now Matthew Tagliani, a derivatives trader working for Morgan Stanley in London, has done it.
Tagliani’s "The Practical Guide to Wall Street: Equities and Derivatives" is an excellent introduction to life in the equities department of a large investment bank or brokerage.
Written by a trader who has done time on the trading floors of three bulge bracket firms over the past 10 years, the book drills down into both the products and how the trading pros handle orders in them.
Within its 528 pages, Tagliani covers cash equities, portfolio trades, options, exchange-traded funds, index futures, forwards and equity swaps. He diagrams how trading floors are laid out–who sits next to whom–and the roles of sales traders, traders and research salespeople.
The material should benefit the junior staffer just starting out, as well as the seasoned pro wondering what happens on the other side of the room. It should also appeal to exchange officials and vendors who service the sellside.
Tagliani’s strengths are arguably on the program trading and derivatives side of the business. He devotes about 35 pages to program trading; 80 pages to options; 50 pages to forwards and futures; 30 pages to swaps; and about 12 pages to ETFs. (He even devotes 42 pages just to equity indices.) The author is a chartered financial analyst with a master’s in applied mathematics who has spent his Wall Street career in swaps, ETFs, futures and program trading.
That’s not to say Tagliani shirks his duties when it comes to cash equities. He spends about 50 pages on the core of any sales and trading operation. He digs into ticks, order types, loss ratios, error accounts, book-builds and other trading minutiae. He reviews not-helds, VWAPs, TWAPs, stops, MOCs, MOOs, CODs, etc. He details block bids and principal trades, and spends an entire page explaining how to "beat the close." He translates trading room jargon and what separates a good flow trader from a bad one when working an order.
We also learn the difference between a good sales trader and a bad one. In addition to common-sense advice about hustle and providing color, we get information about "triple wins" and "quadruple losses."
A triple win occurs when a sales trader discovers that someone in his firm has gotten a sell order in a stock that one of his clients is looking to buy. Because the sales trader has kept on top of internal flow, he can bring the two parties together. The seller gets his trade done quickly and without market impact. The sales trader’s client gets an opportunity to participate and feels well serviced. The house gets two commissions.
The situation can turn into a disastrous quadruple loss, however, if the sales trader is oblivious to the sell order. In that case, the seller gets a worse price; the sales trader’s client loses an opportunity to trade; the firm loses a commission; and the client avoids the sloppy sales trader in the future.
Tagliani’s coverage of cash equities is a little dated. While he acknowledges the existence of algorithms and the movement towards self-directed trading by the buyside, he devotes little space to the two trends that have transformed the business in the U.S. in the past five years. (The book was completed in 2008 and published in 2009.)
He has obviously spent a lot of time on a program desk. His description of the trading process is exhaustive, down to the smallest detail. After a nice backgrounder about the bad rap program trading got after the 1987 crash and the "collars" subsequently introduced by the New York Stock Exchange, Tagliani uses an example to delve into the nitty-gritty of order handling.
We learn about the pre-trade analysis, the use of benchmarks, the execution strategy, progress reports and, finally, the booking. Unlike single-stock trades that are handled with specific share amounts and prices, portfolio trades are discussed in percentage terms and descriptive prices such as the last sale. Trades are done in "slices" or "waves" such as 10 percent of the portfolio. Traders spend their time keeping an eye on how much of a particular wave is getting filled.
Tagliani spends about one-third of the program trading chapter on the ins and outs of blind bids. The practice whereby bulge bracket firms commit capital for their customers’ large portfolio trades with little information about their contents is extremely risky and convoluted. "Why on earth would anyone do this?" Tagliani asks.
The author notes that very few brokers have been able to make money consistently with blind bids, but trying to get customers to play by some sort of rules is an exercise in futility. Still, Tagliani lists five reasons why firms stay in the game. First, clients expect it. Second, considerable information about trading flows is gained. Third, it leads to agency program business. Fourth, a broker’s risk book attracts other flow. Fifth, trading on a risk basis forces traders to understand how each and every stock in the market trades. They become walking encyclopedias and therefore invaluable on the trading floor.
Tagliani’s chapters on options trading are not for the faint of heart. A good grounding in college-level mathematics is helpful, as the calculations that determine options prices are complex. But if the casual reader can get over the formulas and Greek letters here, he will still be rewarded by an excellent description of the players and how they operate. Market makers, volatility traders, and directional traders–they’re all here.
Volatility, or "vol," traders play an especially important role as they make it possible for the customers to take positions. Vol traders are essentially market makers who take on positions and hedge them with trades in the underlying stock. These "delta neutral" positions are then unaffected by movements in the price of the option or stock.
Vol traders are indispensable, according to Tagliani, because the clients tend to crowd onto one side of the market, buying out-of-the-money puts to protect against market downdrafts. If vol traders didn’t step up and sell the puts, there would be little liquidity, Tagliani explains. For their troubles, vol traders end up not with bets on the future price of the option, but on the direction of implied volatility.
So just how does a vol trader trade vol? Better get the book and find out.
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