What Are the 3 Legs of Cash Equities – and Which Are You?
“ Average investors who try to do a lot of trading will only make their brokers rich.” -Michael Jenson, Finance Professor, Harvard
This article describes the foundation of the equities business and is known as “cash equities.” The other parts of the equities business include prime broking, equity derivatives, equity capital markets, delta one, direct market access, algo trading and program trading. I will have to write something on these parts of the business as well because they are big money makers for investment banks. However, all of these equity divisions sit on top of the “cash” milking stool and wouldn’t exist without it. So let’s head out to the barn and see who is holding the whole show up.
I am a stockbroker and I am just one leg of the ever so useful, ever so profitable milking stool that is “cash equities.” My job is to speak to the portfolio managers (PMs) and analysts at pension funds, insurance companies, sovereign wealth funds, mutual fund companies and hedge funds.
I am basically a salesman and my job is referred to as “sales.” Most “sales” have pretty big egos but even if we don’t like to admit it, the reality is we can’t do our job without the other two legs holding us up, namely: sales traders and analysts. Who are these people?
Sales trading is half sales and half trading. Sales traders are the guys you see in the trading floor photos that journalists love; standing up and screaming into one of the three phones they are holding. In reality, it isn’t like this and those old fashioned phones aren’t used anymore, wireless headsets are now the norm. A sales trader’s job is to speak to his counterpart on the client side. Each institutional client will have its own traders.
They are told by the all important PM which stocks to buy and sell, at what price and how much. It is their job to farm out the order to the sales traders at the brokerage firm. They can give the order to broker A,B or C, or all three if they have “discretion.” Some traders have discretion and others just have to give the order to the broker the PM wants to reward. Either way, sales traders at institutions that manage money speak to the sales traders at the brokerage firm and give them the order:
“Buy 10 mn shares Glencore CD over the day. Be no more than 30% volume.”
The sales trader at the brokerage firm will write down and repeat the order to the client with his thanks. He, or she, will then call in the order to the market maker at the exchange or give it to his “dealers,” depending on the market. The dealers are the guys who actually push the keys to buy or sell X amount of shares at a certain time. “CD over the day” means “careful discretion;” don’t get cocky and buy it all at the open. “No more than 30% volume,” means don’t be more than 30% of the turnover, or volume, traded in that stock today.
Sales traders are the macho part of the business. These guys tend to be tough, street smart and aggressive. Most are huge sports fans and colorful characters to boot.
Like a stockbroker, sales traders call the clients every day. They just speak to different people. They need to know about “flows” in the market, which sectors are moving and which are fading to be able to judge how to handle the order correctly. Once they place the order with the dealer or market maker they must keep an eye on it all day and instruct the dealer or market maker when to buy/sell and how much. If the order gets screwed up it is the sales trader who is held accountable.
These are the guys, or girls, with thick glasses in the research department. They “follow” companies and write reports on which companies are good to Buy, Sell or Hold, depending on their fundamental analysis of the industry and the individual company’s outlook.
Analysts work the longest hours and often take their work home with them. You can always tell an analyst: he is the one on the train, or walking down the street in a crumpled suit with a shoulder strap holding up a big black bag stuffed with papers and his old, heavy notebook.
(They love those shoulder straps). Some analysts will follow the same sector and the same stocks their entire career! You can have a senior analyst write about IBM, for example, for 30 years. It is their reports and their views that we stockbrokers and sales traders “broke” to clients.
A good analyst can move the market. If a well known and well respected analyst downgrades a stock from a Buy to a Hold, or even to a Sell, it may cause the stock to crater. Upgrading a stock to a Buy may move it as well. Because of their potential market impact, analysts do not sit on the trading floor – only the brokers and traders work here. They work in a separate office, or even a separate building. This separation is called a “Chinese Wall.”
It is to prevent brokers or traders from knowing what the analyst will do before he publishes his report and it becomes public information. If we knew Poindexter was going to downgrade Apple tomorrow, the theory goes; we might let certain clients know ahead of time thereby giving them an advantage over everyone else. We wouldn’t do that of course, but it is better we don’t know ahead of time anyway.
I have noticed over the years that each of the three legs of the milking stool tends to attract certain personalities. I can usually tell within 30 seconds or so when I am meeting a young hopeful candidate to which area of the business they are most suited. A quick mind and a short attention span – sales trader. Thoughtful and wordy without getting to the point – analyst. Suave and sharp – sales!
Since this is an important area, I wrote another post on personalities and roles here.