Thursday, April 22nd, 2010
vogue traders

Paul Kedrosky recently sent this tweet: “We need a word for putting the world at risk, with managerial permission: What is the opposite of a rogue trader?” In response, I offered “vogue trader.”Infectious Greed | Here’s Kedrosky’s follow-up blog posting on the same topic.

If you followed the link above to Kedrosky’s choice for the best responses to his question, you saw that his top pick was simply “trader.”  That is, while we can try to assign a new moniker to the activities, the trading mentality itself can lead to an inclination to “push the envelope,” with capital and encouragement being readily available from management until the trades stop working.  That’s true in spades at the major investment banks, as the securitization dance revealed.  Proprietary trading, hard to define because it is interwoven with other business lines and sometimes camouflaged by client activities, is subject to the resulting performance and incentive pressures (and potential errors).

The firms are reluctant to share information about the size of their prop trading operations, for competitive and political reasons, but there’s no dispute that they have grown dramatically.  The question is what impact that has had on the behavior of the markets.  Even if we don’t venture into the “putting the world at risk” issues, I believe the increased emphasis on prop trading is part of a general “vogue trading” shift to momentum strategies.

It’s always interesting to speculate on market structure and who’s doing what and why.  There are many different games being played at once; some we can readily surmise, others are hidden to us until well after the fact, and a large number we never really learn about unless something goes really right or really wrong.  That said, it’s evident that trading is king these days.

Now, there’s much to like in how a good trader operates.  Devoid of fundamental inputs, a pure technical trader has the potential to steer clear of the love affairs with positions that can snare a fundamental investor.  There is real power in assessing a trend and adhering to prudent trading rules and money management techniques that help to limit losses and not gains.  And an agnostic willingness to go long or short helps a good trader to eliminate the hope factor and focus on what is working and how to capitalize upon it.  Discipline is the key, of course, and the loss of it, by a trader or a firm, can be devastating.

Throughout the market ecosystem, “trading” now dominates “investing.”  Spurred by the availability of electronic information and trading platforms, that certainly seems the case with active individual investors.  At asset management firms, the career risk is such that most decision makers feel that they can’t afford to be out of sync too long, and have adopted more of a trading mentality than they advertise.  While there’s no way to know for sure in the aggregate, it’s probable that quantitative portfolio strategies have become more adaptive overall as momentum has ruled.  Totally beyond my ken are the effects of high-frequency trading, but it seems likely given the time period of its ascendancy that the algorithms driving it are leaning with the wind.

We may not all be traders now — the market is never any one thing — but the pendulum has swung a long way in that direction.  Will it fall back?  How quickly?  When?  Why?

Since being in vogue has never been so in vogue, it’s time to look in the mirror and decide if you like what you see.