Trader At Large
The Shrinking Role
Of the Sales Trader
Brian Pears
A confession before I deliver my sad tale: I don’t have it in for sales traders; not as a group, nor rarely even as individuals. This mea culpa seems odd until you realize that as a buyside trader, it’s my job to treat everyone on the sellside like a thief breaking into my house.
What’s even worse, under torture, I’d admit my belief that some sales traders do provide economic value. (Read “some” as between 10% and 49% of them, depending on my mood.) In trading, information about true supply and demand has the highest economic value. A good broker can discern that information and deliver it appropriately.
Thus I never bought into the popular belief that ________ (insert regulatory change, or new alternative trading system here) was the innovation that finally would eliminate the need for sales traders in the trading food chain. I understood that the existence of the goal all buyside traders are said to share -- direct negotiation with their peers rather than a broker -– led many to conclude that the next New Thing would finally lead us to the Promised Land. However, knowing that a buyside trader’s actual goal is to cheaply implement a portfolio manager’s decisions by any means available enabled me to ignore those predicting doom for sales traders.
Walls Are Crumbling
But I’ve begun to lose hope for my well-compensated brethren. No one change has cracked the foundation upon which they sit. Rather, the combined effect of all the incremental adaptations is causing walls to crumble bit by bit. ECNs like Instinet, and ATS like POSIT, have chipped away, taking order flow from sales traders. Order-handling rules dictated more transparency, eroding the informational niche that good brokers carve out for themselves. Technology delivered real-time indications of interest electronically rather than orally. Most importantly, decimalization encouraged the fragmentation of order flow into retail-sized chunks, again handicapping traders hired specifically to transact large blocks of stocks.
All of these changes have led to a market in which brokers are asked increasingly to act as agents. The move to commissions on Nasdaq highlights this trend clearly. However, the transformation concurrently provides the mechanism by which buyside traders either act as their own agents, or cut out intermediaries. I don’t need brokers to work orders for me on an ECN or in an ATS. In fact, they just get in the way. And the success of direct-access brokers on the floor of the NYSE shows that many believe sales traders just get in the way of agency executions as well.
Tougher Trades
But what about tougher trades? The more illiquid the stock, or the larger my order is relative to average liquidity, the more important it is for me to find the holy grail of institutional trading: The Other Side. (Derived from the Law of Buyside Trading: For every buyer, there exists a seller of equal size and equal motivation. If this counterpart can’t be located, the broker didn’t do his job and must be screamed at.) Surely a sales trader can always add value by coaxing the two sides to negotiate, right?
In fact, coaxing clients is a primary function of any sales trader. What’s more, a good sales trader can protect his or her buyside client. She can whisper in your ear that The Other Side may in fact be a little bit bigger than you are, and that you might find it beneficial to try to buy stock cheaper. Thus, it has always been assumed that sales traders would exist until someone invented a system that could “whisper.” OptiMark was the closest anyone has come to inventing an electronic whispering machine, and it failed dismally. The role of the informed intermediary seemed safe.
But what people have missed is that the need for a Stock Whisperer is rapidly abating. Like it or not, the volatility of the late Nineties made a majority of traders believe in VWAP-style executions. Traders became happy with average price executions as they realized that waiting to find the other side could leave them looking twenty dollars a share wrong. “Just get it done” became the mantra. The wild price swings have gone, but the mentality has not. And if we’re all aiming for average executions, we don’t need The Other Side like we used to. And we don’t need sales traders as much either.
Soon Find Out
These oft-valuable intermediaries won’t disappear any time soon. As a trader at a third-market firm in San Francisco (a man who is alternately a friend and the bane of my very existence) informed me yesterday, his compensation was up last year by about the same number of basis points as the market was down. Clearly, it’s too soon to refer to these brokers and dinosaurs in the same breath.
But the end may be closer than many think. If so, I’ll scramble to find someone else to blame for my lousy executions. Can you fault an inanimate ECN and get away with it? I may find out.
Brian Pears is the head of equity trading at Victory Capital Management in Cleveland. |
