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11 09 2015 | by Victor Xing | Capital Markets

What do sell side traders do?

Reality is far from the "Wolf of the Wall Street." In-fact, the people depicted in the movie weren't even traders.

Sell side traders working for investment banks perform the following functions for their firms and institutional clients:

  1. Market making and facilitate transactions at a time of client’s choosing without hesitation.  The last point is important – large institutional clients would often shy away from brokers who are unable to provide liquidity on-demand.  Please also see market makerThe foremost compensation for market-making is relationship building.  Institutional clients would likely come back to the same market-maker who facilitated the exit of a $500mm position smoothly, and the market-maker will be able to see more institutional flows and have better insight into these investors’ intentions.  Commission only comes into picture after these considerationsMarket making is about risk management.  Client selling asset A to the trader means trader will need to manage asset A’s risk on the firm’s balance sheet (is it sensitive to interest rates, is it sensitive to spread movements, etc), and since traders know how much risk they want to take, they would use other instruments (such as derivatives – most commonly futures) to reduce or even increase such risk.  It is the duty for the head of the trading desk to know all risk positions on the desk’s balance sheet.  It is not uncommon for traders to get tapped on the shoulder (so to speak) to unwind risk positions if the head of the desk disagrees with holding such risk.
    sell side traders and risk management
    Market makers and risk management
  2. Use trading balance sheet to generate additional profits.  Assuming a sell side trader is very good at #1, the trader will be able to see more flows and have a bird’s eye view on what major market-moving institutions are doing.  If they believe what they are seeing is a multi-session trend, they can make a market call and establish similar positions to generate profit.
  3. Provide market commentary and generate additional flows.  The sales people interacting with institutional clients often do not have their own views (some do, especially my former GS coverage who is really awesome), thus sell side traders supply them with market commentary to be distributed to all clients.Other times they would use the commentaries to assist with their flows.  For example, if a large institution dumps $400mm off the run 3 year Treasury notes on a dealer, the trader may browse through position records (maintained by the sales people – who keep track of every trade made by institutional clients to deduce their positions) and see if any particular clients may need these OTR 3s.  Once found, sales coverage of these clients would send “trade recommendations” to entice clients to buy these OTR 3s off the trader, therefore doing the trader a service (clients in this case become a liquidity provider – knowingly or unknowingly).I remember a particular CMBS trader who would send out “commentaries” that would always end in “in case you were wondering about those bonds that I just mentioned as being very cheap – I can sell $100mm of them at price X”
  4. [Specific to bond issuance] bond syndicate traders would facilitate communication between investors and bond underwriters in gauging potential demand for the bond issuance.  This process eventually result in bond pricing and new issue allocation.

Next article11 08 2015 | by Victor Xing | Capital Markets

What is fixed income trading?