Hi everyone, I have a question that I wanted to ask for a long time, if you guys can help me about it I will be very grateful. I just cannot grasp what differences exist between trading done in Sales&Trading departments of Investment banks and trading done at Proprietary Trading companies & quantitative hedge funds. From the books I've read so far, it seems that there are several categories of strategies such as momentum and mean-reversion. I assume these strategies are employed as a portfolio of strategies at Prop shops and Quant Hedge funds. The S&T's job, I am not sure about it but, is to execute orders that the clients want so it seems that momentum or mean-reversion strategies are illogical to this application. So what kind of strategies do they implement? How much does trading in S&T and prop&quant HF differ from each other? Any info on the topic is appreciated.
Investment banks trade structured products. That's what facilitates their order flow. Prop firms trade flow from exchanges.
Banks trade on the exchanges too. A bulk of a banks trading profits come from exchange traded products. Typically banks make their money facilitating customers (similar to a high end market maker). By facilitating customer flow, they earn a spread, commission dollars and profits of the information generated by that flow. Prop firms typically look to make money by predicting the future. They would be good clients for the bank.
So how exactly do they facilitate customer order flow? What kind of strategies are employed when executing customers' orders?
I'm trying to keep things simple and general. The best way to explain this to someone is by having them understand where the process originates. With investment banks, it's almost always the customer, hence why they are a bank. Prop firms don't have customers. Instead they have flow. So their process originates with the flow of orders usually from an exchange. Both take proprietary positions, but the origination is what basically sets them apart.
So trading in investment banks function like a broker, where customers use the bank to execute their orders, did I understand it correctly? Also, can you clarify what you meant with "Prop firms' process originates with the flow of orders usually from an exchange."? Why would an exchange send order flow to a prop firm? Or am I misunderstanding something? I thought prop firms take positions (according to their strategies) with capital provided by the owner and prop traders earn a premium if they profit.
Both banks and prop firms need to maximize their resources. They both have fixed and variable costs for being in their own respective businesses. Being a bank is extremely expensive both in regulatory costs and in labor costs. So they maximize their resources, which in their case is their customers. They have asymmetric information which has a lot of value. Prop firms don't have customers, what they do have is technology. This is also a big cost both fixed and variable. They also have labor costs. So in order to maximize their technology they work with exchanges to provide order flow. This can be as official designated market makers or an indirect flow provider. Again, they are trying to utilize what they have and maximize their inputs to produce an output. It really almost would seem silly to have guys sit and punt on direction all day while at the same time absorbing the overhead they have. Again, both firms and banks take proprietary positions, but they do so on their terms with their resources. That's the whole point of being a firm in the first place. Otherwise they could just sit at home in their boxer shorts with zero overhead and just trade.