Part 1 (published September 29, 2016) It’s September, when many traders return to the markets looking for opportunity. It’s appropriate then that this third installment of “Wizards of Today’s Markets” features Ray Cahnman, Chairman and Founder of TransMarket, a trader who has been seeking out trades and making markets since the mid-seventies. Founded in 1980, TransMarket has had offices in Chicago, New York, London, Madrid, Sydney, Singapore and Mumbai, and at one time, over 400 employees. In 2016, the firm is enjoying its most robust year in both volume and profits generated. I’m grateful Ray stopped by the Tech Tap to speak with me, as he was very open in discussing the highlights and lowlights of his career. This series is presented as transcripts of the conversations, which have been lightly edited for readability. If you’d like to suggest a future interviewee for this series, please email us. I hope you enjoy, and feel free to leave comments or questions. Rick Lane, CEO Rick: Thanks for agreeing to do this. I suspect most people who are reading our blog and reading this blog post in particular know all about you and how you got your start. But maybe for those who don’t know so much, could you just give me a little bit of insight into the early days of how you got your start trading? Ray: In the early 70s, I was working for a computer time-sharing company, and I made a sales call at the Board of Trade. Rick: Did you say computer time-sharing? Ray: Yes. That doesn’t exist anymore. Rick: That whole notion is? Ray: With computer time-sharing, one could access a mainframe computer, and ask “what if?” questions. It was accessed through a dummy terminal, a teletype terminal that operated at ten characters per second. The company I worked for had a database of interest rates from Bank of America. This database consisted of daily closes. At the time, the CBOT was developing an interest rate futures contract, and I thought that their research department could use my company’s database to run a regression analysis. So, I made a sales call. I didn’t get a couple words out of my mouth before they started selling me on taking an application for their new Ginnie Mae futures contract. As I walked out, I was handed an application for a Ginnie Mae trading permit. I didn’t make the sale, but they sold me. Before leaving, I filled out the application for a permit. I heard a convincing presentation from Doc Sandor, and I was in the Ginnie Mae pit on day one. Rick: Day one of the trading for that contract? Ray: Yes. I was there on the first day trading interest rate contracts. Rick: And what year was that, roughly? Ray: It was in late September, 1975. But prior to that, I had gone over to the CBOE, looked on the floor, and I saw the commotion. I saw people jumping up and down; it appeared as if there were some athletic competition involved. I knew that it was all about numbers; they were shouting out numbers. I didn’t understand what they were doing, but I could see that the activity was competitive and it involved arithmetic. And I was a competitive tennis player. In 1975, I was ranked the number one tennis player by the Chicago District Tennis Association. Rather than having great shots, I got there by having a lot of determination and being very competitive. Similarly, I was good at arithmetic. I had a math degree, but my strength was in numbers, not Greek letters. I believed that if I could figure out how to play this game, I could be good at it. When the opportunity opened up with mortgage futures, I got involved. Rick: It’s funny because, like you said, it’s not complex calculus that drives much of the trading in futures, but it’s the ability to do relatively simple arithmetic really fast. And that was—when I got my start and saw the guys who were really successful and really good at doing this—that just floored me, that they were able to price some exotic strip of futures contracts in net change on the day, basically in their head, on a moment’s notice. And that’s pretty impressive. Only I think a handful of people are good at that. Ray: Yes. But as things have progressed—it’s 2016 now. Computers are way faster. It takes 400 milliseconds to blink, but the transactions that are going on through CME are taking place at faster than one millisecond—at microsecond speed. That’s a millionth of a second. Things have gotten so fast that it’s impossible for a human brain to react like you could in 1975. Rick: I remember when I stepped foot in the Eurodollar and the S&P pit for the first time in 2005—this was back when it was still pretty rocking. But I think for a lot of people getting their start in this industry today, all they have are pictures and history books, and they don’t actually get that experience firsthand. Maybe tell me what your experience was that first time you stepped into the Ginnie Mae pit. What was the first time that you actually saw a floor and you saw those people jumping up and down and shouting and yelling? What was that experience like? Ray: Look. It was real scary for me when I first went down there. Rick: It’s intimidating. Ray: I didn’t have much. After paying a $5,000 fee for a six-month permit, I had $3,000 left. It took me a long time to find anyone that would clear me. Why would anyone send someone down to the pit that had only $3,000 in capital—they’d have to be nuts to do it. The firm that cleared me, Shatkin—they did it more as a contribution to the Board of Trade. Doing their share in helping this market survive, they cleared one local that didn’t have much backing. The first day I was so scared that I didn’t execute a single trade. On the second day, I made a trade and lost three ticks. That was close to $100. I figured that, if I did this every day, in 30 days I’d be tapped out. My reaction: I didn’t trade for the next two days. Rick: Trying to extend your career a little bit. Ray: Right. And then on the next day I had an out trade. I thought I was buying, but the person I traded with was also buying. I’m sure I was wrong, because I was the new guy, and I was trading against a very experienced trader. He should’ve stuck me with the whole error, but he agreed to split it, and that saved me. I needed every tick that I could get. And I was able to survive. At the end of five months, I was the leading trader down there, and I was a thousand dollars in the hole. Our six-month permits were just about up, and we all went on strike. We said that if CBOT didn’t waive the next six-month fee, that we were all quitting. The Board of Trade waived the next six months’ fees. Rick: Was this the first rebate system in place? Ray: CBOT knew that they needed traders to stand in the pit and make markets. And no one would go in the Ginnie Mae pit if they could trade soybeans or corn. So they were forced to extend permits for another six months. The Board of Trade originally tried to sell 100 permits, but they only sold 19, because even today, the odds of starting a new contract and having it succeed are very, very small. So it seemed like a real bad bet. In retrospect, it was a bad bet. And that’s why only 19 stupid people bought permits. But starting at about the fifth month, instead of going up $1,000, down $1,000, I was up $2,000. Then up $4,000. And I was still scared. So I just put everything in the bank. I figured for sure it’d reverse again. But it didn’t. I kept accumulating ticks, and wanted to stay there because this job was really great. I didn’t have to report to anybody. I didn’t have a boss that I had to answer to. If I didn’t show up, the market didn’t care, it survived. It was an ideal situation for me. I didn’t have to play politics with anyone, and I didn’t have to split anything. Whatever I made, I kept 100%. That very much appealed to me. And I also had very low aspirations. My goal was to make $15,000 a year. I could put food on the table and buy tennis balls. I didn’t know if I could be successful. I might have a bunch of days where I’d lose. Therefore, I saved as much capital as possible to give me security in order to survive a bad run. Rick: But it sounds like you had more winning days than losing days. And that longevity is fairly unprecedented in this industry. Do you attribute anything in particular to that longevity? Ray: I think part of it was having the shit scared out of me a couple times. Following a big winning streak, I bought a membership. I loaded up on some back month mortgage spreads. One day I’m looking at the market—it was on a Friday and I’m realizing, nobody else is buying. They’re all selling. It was a very thin market, and I didn’t know where I could get out. So I went up to [Henry] Shatkin and I said, “I have a problem. I don’t know where I can get out this position.” And he said, “Well give me a guess. What’s your exposure?” I told him that I really didn’t know. He said, “Take a guess.” I got scared and I said, “A million dollars.” And all of a sudden I saw his Adam’s apple bounce up and down and he put his arm around me and said, “Well, I’m sure it’s not going to be…whatever it is, go home, bring in all your bank accounts, let me know what you have, and we’ll take care of this on Monday.” Rick: I’m sure that was a long weekend. Ray: I didn’t sleep the whole weekend. I went down on Monday morning. I dressed up. I put on a suit. Because I only wear suits if I’m going to a funeral or perhaps if I’m indicted. I knew this was my funeral. At Shatkin’s desk, with all his partners standing around, he says to me, “Ray, we’ve discussed it—we talked to Doc Sandor, you’re going to get a bid. He’ll bid 32 ticks under the market. It’s going to wipe you completely out. But we’ll worry about that later. At least you’ll be out.” Shatkin added that the orders to liquidate were written up. I told Shatkin, “Look, if someone’s going to put a bullet in my head, I’d rather do it myself.” He said, “Just a minute.” All his partners went in the other room and they discussed it—should they let me go down to the floor? Could they trust me to blow out? Because it was known that if someone had to blow out, often they would double up instead. Finally, they came back and they said, “Okay, you can blow out the position yourself. But you better make sure that you do it.” So I go down to the pit. Everyone knew what was going on. Shatkin’s partners were down on the sideline to make sure that I wasn’t going to double up. As I called out the spreads it seemed as if the whole world had just surrounded me. And Doc Sandor even walked off the desk and he’s standing next to me bidding in my face, 32 ticks under. And finally, someone from the silver pit walks over, bids 16 under the market. I said “sold”. And then everybody else comes up—they’re saying, “Hey, I’m bidding 16 ticks under the market, why didn’t you split it up?” And I told them to all get lost. And I shook the hand of the guy that paid 16 ticks under. I said, “I hope you make a lot of money.” I walked out. And I survived. I basically had nothing. I wasn’t in the hole, but I didn’t have any liquidity. From that point on, Shatkin, for the next several months, made me trade one lots. That’s all I could do, and that taught me a big, big lesson: never go all in. I’m going to know what my exposure is. I’m never going to bet my family or my livelihood. I’ve seen lots of traders over the years go all in. It’s one thing to lose for themselves, but I have no respect for people that will bet on their wife or their children’s future. That’s out of bounds. The first million dollars that I made I put aside. I pretended that it didn’t exist. I’m never touching that. I’m starting all over at zero so I’m never in that position again. This discipline allowed me my longevity. I would bet big, but never the whole farm. Rick: You always knew what your exposure was. Ray: Yes. Part 2 (published October 2, 2016) Rick: Would you say that—we’ve all made bad trades and probably learned more from those than from the good trades—but would you say that [your narrow escape with the back month mortgage spreads] is the story that underscores your approach to the rest of your career? Ray: That was the worst, and there’s no question that you learn more from your bad trades. You make a good trade and the question you have to ask yourself is, was it skill or luck? And if I had to do it all over again, would I do it the same way? When you have a losing trade, you can’t beat yourself up too bad. If you did everything right, and you still lost, you’d say, “Well, if I had it over again, I’d do it the same way.” In any sport, in any game—trading, tennis, any competitive sport—you learn more from your losses than from your wins. If you win, you kind of chalk it up—that’s on the scoreboard—and you go on to the next. The loss—you have to go back and re-analyze what happened and what you did wrong. And that’s especially true in trading. And you try and avoid making the same mistake twice. Rick: So you’ve obviously embraced electronic trading, but do you feel that the industry has lost something with the closure of the pits? Are you nostalgic or do you think we’re better off now? Ray: I’m not nostalgic at all. I’ve been asked by a number of people to talk about the “good old days.” From 2000 to 2003, I was a director at the Board of Trade. I could see electronic trading coming. Open outcry should’ve ended long before it did. It was a very frustrating time, because I had to fight a board that was dead set on preserving open outcry. The mantra at the Board of Trade at the time was, “We’re going to provide the customer with the best of everything. The best of electronic and the best of open outcry.” It made no sense. There should be a single marketplace. The most efficient way to have a market is when everyone knows where the party is. To have both an open outcry party and electronic party is inefficient. And I could see that the technology was catching up, and that electronic trading would be taking over. It should’ve happened many years earlier. Personally, I was focused on getting ready for electronic trading. Back in the early 90s and late 80s, I was following voice recognition. At that time DOS was in use. Windows did not exist. The screens didn’t have the graphics that they do today. Rick: I remember DOS. Ray: It now seems inconceivable. But I thought that the future of electronic trading would involve everyone sitting in front of a computer and being able to yell into a microphone. I imagined that the computer would sort out who’s first. I kept paying attention to voice recognition technology. I had predicted the wrong adaptation, but I knew that electronic trading was going to prevail. Rick: And about six or seven years too far in front, too. 2005 was when I came into this industry, and that’s back when I saw the Eurodollar back-month spread pit for the first time—in the fall of 2005. And then by the summer of 2006, it was like you could hear a pin drop. It was so quick and I’m sure there’s countless other pits that have a very similar story. Ray: Your experience is interesting, because by that time I had been off the floor for a few years. The Euribor, which was a similar contract but for Deutsche Marks and then eventually the Euro, was traded actively on the screen at LIFFE. Euribor used a pro-rata distribution system. And that’s what made it work. You couldn’t trade Eurodollars, a spread market, on a FIFO distribution system, especially in the back months. I kept telling the CME that they had to go pro-rata. Eurodollars were displayed on GLOBEX but fills were distributed FIFO and it had no traction. So, very little traded on the screen—it was all in the pit. Finally, they made the algorithm pro-rata. Then it had a chance. I started playing Eurodollars electronically and I started playing it big. Most everyone was afraid. In a pro-rata system, you have to bid—if you want— Rick: If you want ten, you bid— Ray: You bid for a hundred or whatever. Sometimes, a calendar spread quote might be as much as 50,000 up. So I bid one tenth of it, 5,000. Other clearing members would not allow their traders to place orders that big. They’d have to trade the maximum of what they wanted. So I’m trading and I’m getting the lion’s share of the pro-rata distribution. Everybody else is putting in bids and offers for like maybe a hundred, whereas I’m putting in for a thousand, 5,000, or 10,000. Rick: As long as when the market turns you’re able to get out. Ray: My TT machine, every time it made a trade, it would clap. And it was clapping all day long. I didn’t even have to look. I was getting small pieces that added up. And the years 2005, ‘06, and ‘07 were great years for trading Eurodollar calendar spreads. 2008 was my very best year. I was cranking out enormous volume. That lasted through 2009. In the beginning of 2010, it started to diminish. There were two underlying reasons for this. First, Spread Networks came in and sold access to a faster fiber optic connection. Traders were faster, and then also people were smarter. People caught on to what I was doing. And secondly, algorithmic traders started developing programs that tightened up the spread. Spreads didn’t get out of line as often as they did up until 2009. That had a devastating effect on the people that had transformed from the pit to the screen and were still active and viable trading electronically using front ends like Trading Technologies, which was the most popular front end by far. I have an interesting thought for you. I was always very much in favor of pro-rata distribution for everything. And I kind of wonder what would happen if SPOOs, which are basically a FIFO, were distributed on a pro-rata basis. Rick: It would be interesting. Ray: It’s already a done deal, but it would definitely have changed the speed game. And I saw it right from the beginning. I knew that a distribution based on FIFO markets would lead to an Oklahoma land rush. The guy that was the fastest was going to get it all. If you weren’t the fastest, you weren’t going to get it. And eventually— Rick: Or if you weren’t there the longest. So you had the people that—you’d line both sides of the book with orders, beginning of the day, so that you could work your way to the front of the queue. Ray: That’s right. Yeah, it was all about getting to the front of the queue. It’s something that, as we’ve gone on, as people have been able to get their orders in quicker, has been to the detriment of traders without access to a fast connection. That’s one of the big problems that the exchanges have. Rick: I’m curious. You run a principal trading firm. What advice, if any, would you have for the CMEs of the world? Ways that they can improve. Ray: First of all, you have to understand the CME’s role. They’re like the umpire and commissioner in a baseball game. They set the rules. And it’s real important that they set the rules so that everyone can get a chance to compete fairly. And they have to oversee it and make sure that happens. In baseball, it’s 90 feet from home plate to first. It’s an entirely different game if it’s 89 or if it’s 91. Similarly, the CME has to draw a fine line. I think that they could do a much better job by looking at the game and seeing how they can better level the playing field. The CME should set the rules to drive the maximum amount of volume through the system. They should strive to get large numbers of traders actively participating. This would be in their self-interest. Currently, 90% of the volume is going to 10% of the participating traders. However, if they had a broader distribution of their trades, they could grow faster, attracting more people to become involved in the game. Is fill distribution today the most efficient? Is the way they’re operating now the best way to drive the most volume and get the most people involved? They can do better. But will they? I don’t know, human beings are creatures of habit. When they get used to something, they’re not likely to change. For instance, in the pit, everyone quoted yield curve spreads based on up or down on the day. And they did that because—I’ll buy the ten-year bond spread. I’ll buy it up one tick on the day, or I’ll buy it up two ticks on the day. Rick: Because they had positions coming into the day? Ray: They did that because that was the only way you could communicate in the pit. Because quoting based on three times the TY minus two times U.S. had to be communicated verbally. You had to talk in shorthand in the pit. Now, there’s no pit. So on a computer, it’s pretty easy to create some sort of an index, and if you had an index, then you would be able to attract people. Even though you may not be able to quote it in terms of basis points or yield, you could quote it in terms of an index. On Monday, you could see that you bought the index at one price, and on Friday, the index is higher. I know how much higher and determine what my gain or loss would be. The CME would absolutely get more players trading the yield curve if they could quote it in terms of some sort of an index, as opposed to up or down on the day like they do now. This would be a marketing dream for the CME. I have a large amount of CME stock, which I have no intention of selling. I think it’s a very safe investment. It pays a good dividend. The CME is a very good company. But on the other hand, I think that they could be a lot more innovative than they are. Take a chance. Quote your yield spreads in some sort of an index. And see what happens. It took so long for the pit to change, for the CME to embrace technology. Learn from one’s mistakes. Rick: It’s an industry of great inertia, as you know. And sometimes it’s— Ray: It’s because it’s a monopoly. They’ve got a franchise in interest rates. They’re so entrenched that nobody could possibly come in and take it away because the party is at the CME. Rick: You’re absolutely right. There is one other thing. I don’t know if—we found this picture when we were doing our homework on you. Ray: No, I love it. It shows my son—it has to be 2007 or 2008. And we’re in front of my bed. Since trading was going 24 hours a day, and I had orders in all night, I would have my screen on at all times. Rick: The screens look familiar. Ray: Yes, it’s Trading Technologies. And it would clap when it made a trade. And my wife was fortunately a sound sleeper. Rick: I’m sure she was thrilled about that. Ray: The other thing is that I mentor a lot of people trading from an identical trading setup downstairs in my library. I could see what they were trading. I had to get some sleep, but I often woke up when a trade was made. I was always in a bad mood, and when they did something wrong, I’d make some not-so-gentle criticisms of what their mistakes were. Rick: Hopefully you didn’t start that young. You didn’t start them that young. (points to photo) Ray: No, but actually, for some of the people that were down there, when they made a mistake, I would yell down to them. I’d say, “My three-year-old could do a better job than you. Show me your diploma. I don’t believe you ever graduated grammar school.” By the way, TT has been very innovative in terms of creating tools. If it wasn’t for TT, a lot of traders would have never been able to crack into the market and create algos. Rick: That’s great. Have you dabbled with ADL® yourself? Ray: I stopped trading about a year and a half ago. At TransMarket, we utilize our own algorithms with proprietary software. We also use TT for markets that aren’t quite as active. ADL looks to be very promising. For new markets, we get access through TT. For the smart guy that wants to figure out the market on his own—the lonesome cowboy-type trader, or perhaps a small group not affiliated with a big company infrastructure—they can work effectively with the tools at TT. You either have to be the fastest, or be smart. Utilizing the tools that TT offers gives traders an opportunity to develop a strategy. There may be a hundred different algorithms that are focused on attacking various things in the interest rate market. There’s always the possibility of creating a new and different algorithm that looks at the market slightly differently. There still exists a population of talented individual traders that have survived. Those traders have no choice but to speculate. They have to be directional, pick their spots, and be very patient. The trades should not be large. They should execute a few trades a day. Consequently, those traders make a fraction of what they were able to do when they could trade a lot of volume. However, the exceptionally bright traders that can work with TT products can have tools to automate, execute, and sit back and see it work. There are likely a few people that have really done well trading through your products. Rick: We have had our fair share of people. Ray: If you’re coming out of a good school, you know math, and you know logic, and you can see how the markets work. You have to know how to create an algorithm. You have to broadcast the message to traders that if you’re a capable and creative thinker, our products [futures] are a great fit. You don’t have to be a Nobel Prize candidate. Rick: I appreciate that. I think it’s where we’re constantly trying to lower the barrier. This even goes to what you’re talking about with CME and trying to increase their distribution and trying to lower the barrier. Ray: I could tell you something. As long as you said that, “the barrier.” Are you watching membership prices? Rick: I stopped watching them when I sold mine. Where are they now? Ray: To apply for a membership, it’s still a $2,000 application fee. But to lease a CBOT Associate Membership, the posted monthly rate is $476, but since there are over 50 available, the offer price is much lower. Posted lease rates for IDEMs and COMs are $30 and $130 respectively, with over 40 IDEMs and 60 COMs available. So, the thing is, the application fee is a big multiple of the monthly lease fee. It makes no sense because the break-even point between being on a membership or trading through a firm under their umbrella is nine cents. The bottom line is that the $2,000 application fee is completely out of line with the low membership lease rates. It just stops people from applying for memberships. And the lower the lease price goes, it just makes it stand out even more. If you want to trade on the CBOE floor, you have to buy a permit. CBOE got rid of all their memberships. So if you want access to their markets, you buy a permit. If CME would get rid of all their memberships and buy them up—all they have to do is bid under the market and catch them as they come in. CME could then issue permits. It would generate revenue. They could find a number that would make it revenue-neutral. In the meantime, I think CME is handicapped by having a complicated pricing structure; impossible to figure out. Right now, it’s much cleaner for a new trader to start trading ICE, or Deutsche Börse or any other exchange that doesn’t have the burden of memberships. Rick: We could talk for hours. Ray: I’ve had a unique experience. I was a high volume trader and I ran a clearing firm. I was exposed to everyone’s stories coming through. Sadly, I knew what was going on in the heads of all these people as they were going from big-time success to failure. I’ve had people call me when they’re living out of their cars, doing menial work. Mowing lawns. I’m reminded often of when Shatkin was going to blow me out, and I almost lost it all. I’m never going to let that happen. _ _ _ I got the sense that we only hit a few of Ray’s best stories, but that’s one of the nice things about having the Tech Tap. I’m confident he will be back when the time is right to share more insights and trading tales from his distinguished career. Installment 4 from our Wizards of Today’s Markets series, where I interview Jack Schwager, author of the book Market Wizards and co-founder of FundSeeder, will be published later this fall.