CHAPTER 11

Choosing a Proprietary Trading Firm

When I left Swift Trade Securities, it was on good terms. In fact, I had been offered a salaried position at that branch of Swift on my return to Toronto, which I would later come to learn was actually an incredibly rare offer to be given to former traders at any non-bank proprietary trading firm.

Despite all the negative publicity related to Swift Trade—or its founder's subsequent entities—in its dealings with Canadian regulators, or the impression that many may have about its trading strategies based on mere word of mouth, Swift Trade Securities was undeniably an excellent place for a trainee to start out in the trading business, especially in the era before and during the early implementation of Reg NMS and the Hybrid NYSE market. On top of that, it would be fair to say that my particular reasons for leaving the company were entirely for practical and personal reasons and in no way reflected how I was treated and trained at the company. In fact, leaving it was probably one of the most selfish decisions I ever made in my career within the securities trading industry—which says quite a bit in a business that's supposed to be driven by primal dynamics of personal gain and cutthroat competition.

As my relationship with Anna progressed, we settled on a transitional period in which she would live in Buffalo, New York—the not-so-beautiful little city that's situated immediately on the U.S. side of the American-Canadian border between New York State and the province of Ontario. We had stayed in Buffalo prior to a vacation when we decided to look up the local ads and realized that the monthly rent for a decent sized apartment in Buffalo would cost less than a shoebox in either Toronto or New York City. Her plan was to stay there until she had a practical and legal means to become a permanent resident in Canada. In the meantime, she had long made it clear that she needed to live away from her family in Staten Island for a number of reasons—not the least of which included the constant arguments—and was up for the task of starting fresh in Buffalo. I was naturally in favor of the plan, considering the much shorter travel time between Toronto and Buffalo.

With my live trading track record at Swift Trade, a number of New York based proprietary trading firms had already offered me positions on their trading floor. More important to me, at the time, was that a few of these companies had also offered me, as an alternative, positions with the opportunity to trade remotely, which was touted as an option that would never be offered to traders at Swift Trade at the time. Such boasts were, of course, considered to be among the blatant trader poaching tactics that were generally frowned upon by many of the firms in New York but is nevertheless practiced by many and, as I later learned, was even more common among Toronto based firms.

Trading remotely was, of course, an excellent choice for my situation at the time. The constant yelling at monitors, amusement at CNBC commentary, swearing at sudden market action, occasional dirty jokes, and overall camaraderie of working on a trading floor would be missed. The priority, of course, was to balance the probability of success on two of my life's biggest trades at once—financial and personal.

On my last day at Swift Trade in Toronto, Liz took the opportunity to warn me about the choices out there among prop firms. Naturally, I considered the source but I always did and always will appreciate everything she encouraged me to do in this industry, and I gave her last piece of advice the same merit.

I networked a bit more with other experienced prop traders, both locally and otherwise, to get a better sense of the industry norms at the time and to update my perspective of the industry as a whole. Of course, having become a part of the experienced trader classification, it became much easier this time around to gather information about the choices of proprietary trading firms that were active at that time.

In fact, as I learned more about the companies in both cities, I was surprised to discover that Swift Trade was among the few independent non-bank proprietary trading companies at the time that would accept new traders, with zero prior trading experience and no verifiable track record, without requiring some form of risk deposit to join the firm.

To be clear, I am by no means bashing the companies in this segment of this industry who do require a risk deposit for entry. In fact, I would argue that many of them continue to provide a very valuable service to beginner traders who might otherwise have built their entire trading education on the beliefs and opinions of struggling retail traders who expend more effort on posting pessimistic criticism on Internet forums than on developing profitable strategies. The original reasons for requiring a risk deposit from new traders who have no verifiable and proven track record should be plainly obvious, of course. There should be no doubt about that. And to be fair, like any part of the securities industry at practically any point in its history, there is also no shortage of questionable and so-called gray area exploitation among the personalities who occupy the company ownership and management roles, so the pessimism shown by the typical critic of all forms of proprietary trading firms is also completely warranted in many cases. The point was simply that Swift Trade was, in fact, a rare gem among its breed and very few of its peers at the time had offered the opportunity that it offered to inexperienced beginner short-term traders in the equity markets.

Today, many of the non-bank proprietary trading firms also require new trainees to present an impressive resume. In this part of the securities industry, the term impressive when referring to a resume would generally be defined by a history of participation in competitive sports; a proficiency in either poker or a similar game of probabilities; or a combination of mathematical skills and one of the above. The ability to show that one is capable of excelling at such skills in an interview would also be an asset. A degree from a prestigious business school would typically be an asset for an analyst position, but very few independent proprietary trading firms will hire traders based on this alone. And one that does probably doesn't have a management with a decent understanding of the trading business (one exception to this would be in the case of an applicant who shows strong proficiency in math, particularly statistics, especially if the firm specializes in particular styles of trading).

Among some of the smaller companies that do require a risk deposit from beginner trainees with no prior experience, your odds are the highest with initial entry into the company's training program, as the company is obviously not willing to risk its capital on your abilities until you have proven yourself. You will have a chance to get a foot in the door with the company's minimal qualification requirements (which, of course, will still vary depending on the particular company you are applying to) but don't underestimate the challenges that will be facing you as a beginner trader even if the entry requirement itself may appear to be lower at face value. Keep in mind that if a proprietary trading firm is willing to take you on board with minimum entry requirements compared to its peers in this industry, the company is also prepared to accept a large trainee turnover—essentially, the company will minimize its internal risk exposure to your trading abilities while maximizing its own ability to find talent among a large group. Be prepared to prove yourself in competition with a much larger peer group compared to the relatively smaller group of trainees who may be accepted into a company with more stringent entry requirements.

While you may experience your fair share of company politics through training or working at a prop firm, it's worth pointing out that being a proprietary trader is probably one of the few positions that remains chiefly a meritocracy. Countless other types of positions in this industry may be offered to, and retained by, those who excel primarily at peer networking and overall ass kissing of company superiors, but an unprofitable trader is an unprofitable trader even if your past three years' performance may have been among the top tier of your peer group in this industry. Your recent track record will get you into the door of a company if it shows a decent bottom line in the green, but your performance today and tomorrow, and every day after that, will be the real deciding factor of how long you can keep your position. Of course, your performance is also directly proportional to your paycheck in this line of work.

With that said, depending on the firm that you land a position in, it's also worth mentioning that if you have a particularly competitive attitude, it may be a good idea to keep it in check at times when it comes to your interaction with fellow traders on the same trading floor. Some proprietary trading firms' management might prefer to encourage a more competitive environment on the trading floor than others, but in my personal experience in the industry, it's generally a good idea to build on your camaraderie with your fellow traders even if a friendly competitive rivalry is involved. What types of strategies are effective, and which ones aren't, in any particular period in the markets could change at any time. If you're on a winning streak, and all your peers are begging for tips, it's not a bad idea to share a few with them. At the very least, you may receive some pointers in return when the market conditions become perfect for a style of trading at which one of your peers excels.

From the perspective of firm management, there's very little benefit to traders sharing entire trades, as it reduces the diversification of strategies in the company's net exposure. However, if it's a question of augmenting one trader's weaknesses with another trader's natural strengths, encouraging traders to share their primary strengths in this way can also form something of an internal hedge for the company's downside exposure and benefits every party involved.

In any case, for better or for worse, a competitive and cutthroat nature can be beneficial throughout this industry. Just keep in mind that there are times when it might work in your favor to give your fellow trader a little help when you're at your best. In most cases, it's unlikely that all your strategy's liquidity would dry up instantly even if you shared every detail of your approach with your entire trading floor.

Once you find yourself in a place where you've actually received multiple offers from different firms, particularly if the nature of the offers is very similar, then it's also worth learning more about the culture of each company as well as the styles of trading that the company management has experience with. Some firms might specialize in a style of trading that outright conflicts with your personality and your natural strengths. Others might simply have a company culture that doesn't suit your temperament. Even if you choose to trade remotely, your compatibility with the management—and, depending on the amount of online interaction available, possibly even your compatibility with your peers—may make all the difference in the world when market conditions are not optimal for your strategy, style, and personality.

Some companies like to post trader profit and loss numbers like a scoreboard. Others prefer to encourage a more us-versus-them team atmosphere. Some branches might even provide an environment where traders are encouraged to share ideas to develop new strategies as a team. I'm sure there are a large number of other variations to this from one extreme to the other, so there's definitely no one-size-fits-all to a prop firm's internal culture.

As a practical matter, almost all non-bank proprietary trading firms in the equity trading industry today will also have to cover their costs by passing down their software fees, commissions, and a profit split. In my training class at Swift Trade, beginners' monthly software fees were covered by the company at the start. Many other companies may offer a similar deal to be fair to beginners. Commissions in general will vary depending on your intended style of trading, but will almost unanimously be drastically lower than the standards of commissions you may be accustomed to with retail brokerages. For instance, as of this writing, $0.001 USD per share (there are two zeroes after that decimal point, that is not a typographical error), which works out to $1 commission per 1,000 shares traded, is actually considered relatively high for a scalper who trades more than 100 times round-trip per day with decent sizes. However, depending on your city, it may still be considered an acceptable offer if your strategy is a relatively less active style such as a form of statistical arbitrage.

An interesting note about the industry as of this writing, as well as most of the half decade prior, is that competition among proprietary trading firms in Canada, in combination with lower overhead costs, has actually brought equity trading commission rates exponentially lower in Toronto than they are in New York City among non-bank proprietary trading firms. A profitable scalper with a proven track record can typically negotiate a rate of 0.0002 USD per share (three zeroes after the decimal), which works out to 20 cents U.S. per 1,000 shares traded, with any Toronto or Montreal based proprietary trading firm. A few companies in New York may offer a rate in this range depending on exactly how impressive your track record may be, but this is typically an exceedingly aggressive offer from any company in the United States, while it's considered more of a norm in Canada.

Last but not least is the profit split percentage. The profit split percentage at Swift Trade began at 35 percent for beginners. Profit splits are always quoted from the trader's perspective; so an offer of a “35 percent profit split” means that 35 percent of trading profits will be paid out to the trader while 65 percent will be retained by the firm. Once a trader has proven a decent consistency of profitability, Swift offered incremental increases in the profit split percentage. Early on, many other firms began to poach profitable Swifties by offering higher profit splits. The most aggressive profit split offered to experienced traders with verifiable track records is typically up to 85 percent in Toronto and New York. Don't expect the top offer unless you can justify it with a proven and verifiable track record. Of course, your mileage may vary if you negotiate with firms in another city.

A number of proprietary trading firms have actually offered a 100 percent profit split to experienced traders. In many cases, traders have become suspicious of prop firms who offer these 100 percent profit split deals as they effectively create a situation in which the company's interests are not entirely aligned with the trader's interests. (Effectively, the firm's revenue would only originate from commissions rather than a trader's performance.) Of course, as unintuitive as it may seem, there are actually some exceptions to this rule, as a few reputable firms have actually offered 100 percent profit split deals as part of a very different business model and management style, which they manage to operate without any direct conflict of interests with their traders. The prop firms of this category can, in some cases, still offer a very valuable service to active traders, especially when compared to retail brokerage commission rates for equities. Just tread carefully in these situations and do your own due diligence about a particular company, especially if such a company requires a risk deposit.

If at all possible, try to track down a few members of a prop firm's current roster of experienced traders and ask around—try to get a feel for the company's legitimacy as well as its reputation within the industry. Not all reputations are necessarily deserved, so keep a healthy dose of critical thinking in play at all times, as in any other area of the markets. In many cases, the negative reputations and criticisms of a company originate from a firm's competitors and other hearsay sources such as former trainees who failed in the program. Still, you might be able to make a more informed decision by learning as much as you can about how the company's current and former traders, as well as its competitors, view it so that you can paint your own picture of the company and its management. In a few cases, you might even be surprised to find that in spite of the fierce competition and a few PR wars between many of the leading non-bank proprietary trading firms, many companies and their management continue to maintain a certain level of mutual respect for their most reputable competitors. It may be rare depending on your city, but it happens. As usual, do your due diligence on a company even if your only investment may be your time.

Creditors, of course, are always doing their fair share of due diligence on individuals within the confines of the system. As it turned out, Anna's credit rating had been destroyed in a series of incidents involving her family members, which she had recounted to me a number of times in the past. Her best friend, Bridget, who had also become a close friend of mine by then, accompanied us on the apartment hunting trips through Buffalo. After visiting three apartments around that border city, it seemed to us all like it had become clear exactly why the rent was significantly cheaper than it was in Toronto and New York: Inner city Buffalo actually looked a lot worse than the worst parts of Scarborough (Toronto) and Staten Island (New York).

Just as we were ready to give up the search, we stumbled onto a listing from Grand Island just off one of the interstate highways that connect Buffalo to the Canadian border. As it turned out, Grand Island was arbitrarily divided into American territory, but could just have easily been a part of Ontario. On that note, it should also be worth mentioning that if the entire Canada and United States national border were as straight on the east side as it is on most of the central provinces and west coast, the part of Ontario that includes Toronto would easily have been part of New York State. In my experience, it has often surprised Americans that my Canadian city of birth is actually farther south than the north end of Illinois. Believe it or not, I'm actually not jumping on the American education system bashing bandwagon by mentioning that—I actually can't because all my fellow Ontario separate school-educated Canadians are equally ignorant about geography except for those who voluntarily decide to research these things on Wikipedia. To put this into perspective, I've spoken to a number of traders in both Toronto and New York City who can tell you the current rate of the euro versus the U.S. dollar within a couple hundred pips before they could tell you where Germany is located in relation to France. It would be much less of a surprise that very few people who grew up in either Toronto or New York would likely know of the existence of that little part of the Canadian-American border that is actually divided in a way that a piece of Ontario, Canada, is to the west and a piece of New York state is to the east. And one little island in that part of New York state is Grand Island, a little town with a tiny population reminiscent of the one where I grew up.

The apartment advertised was comfortable, spacious, and occupied the top floor of a small building in a neighborhood that was an undeniable paradise compared to the inner city of Buffalo. It was located across the street from a small theme park, and was within walking distance to everything from pharmacies and grocery stores to a Blockbuster (at the time) and a bowling alley. There was also a pizza place that I would grow fond of over the months to come, in spite of the fact that both Anna and Bridget would religiously insist that it was nothing like New York-style pizza.

After discovering this apparently unique gem in the Niagara region, we were of course ready to sign a one-year lease for the top floor apartment. Of course, fully aware of Anna's credit rating issues and considering the monthly rent was right around my largest profitable day at that point in my career, I had no problem signing the lease agreement in my name—except for the fact that I was a Canadian citizen. Generously, Bridget offered to expose her perfect credit record to our transitional temporary home between Toronto and New York.

It felt like we had collectively entered an order to open a trade that would swipe the entire displayed offer side of pre-split Citigroup. Well, maybe not quite that size in nominal U.S. dollars, but for a New Yorker with a massive college loan, Bridget's bet on our relationship—or at least on my personal creditworthiness—was much larger in proportionate risk from her financial perspective than that of any firm who would swipe a whole level on Citigroup. And, to this day, I can't begin to express my gratitude to her for the credit risk she was willing to take on by doing us that particular favor.

It was February, 2007.

The S&P 500 Index was still headed to new all-time highs in the coming year. A mortgage securities crisis was still mostly the talk of people who were generally considered “perma-bear” fringe conspiracy theorists. Even the Canadian talking heads on ROB TV (now BNN) were still celebrating the bull market, especially among resource names on the Toronto Stock Exchange (TSX, an acronym likely used to differentiate itself from the Tokyo Stock Exchange, which is commonly abbreviated as the TSE).

And there I was, trading remotely from the obscure location of Grand Island, New York, progressing in a relationship at a seemingly perfect location that seemed to have no end to the upside anywhere in sight.

Few predicted correlations between the S&P 500 and the Canadian resource sector if and when the credit crisis would hit. Fewer predicted that such a crisis would trigger in the autumn of the following year. Even fewer, with any rational mindset, would have thought possible that any part of a former-Swiftie's personal life could possibly be correlated with the S&P 500 chart at any point in time, let alone one of its most historic points of the decade.