Introduction to Sales and Trading (S&T)
Aimed at those interested in a summarised and broad overview of the Sales and Trading (S&T) industry, this article briefly introduces what S&T is, key terms, trading strategies, and recent events that have shaped the (S&T) industry in the past few years.
The role of Sales
The sales team communicates directly with hedge funds, mutual funds, and other financial institutions to deliver information regarding securities and financial products. They interact with institutional clients to provide updates on global market trends and potential investment opportunities. A deep understanding of financial products brought about by the trading team is required in order to provide valuable insights to clients. Additionally, the sales team works with traders to price and execute orders of desired trades.
The role of Trading
Traders buy and sell securities on behalf of their clients while making a profit on a spread, which occurs when they purchase securities at a lower price than the price quoted (see key terms below). Traders specialise in trading different asset classes (mainly fixed-income, equities, commodities, foreign exchange, or derivatives).
The role of Portfolio Management
Portfolio managers create and implement investment strategies to construct and manage portfolios. Their role is to consistently analyse and hedge risk for the portfolio while making decisions on what and when to buy and sell investments.
What is market making?
Market making is an activity that provides the market with liquidity while helping the market makers profit from the difference in the bid-ask spread. Market makers are compensated for the risk of holding assets because they could see a decline in the value of an asset after it has been purchased before it's sold to a buyer. One famous example of a market maker is the US-based hedge fund Citadel, which made about $28 billion in revenue in 2022 managing just over $60 million in assets.
Key terms in Sales and Trading: Offer / Bid / Spread / PnL
Offer: the price at which the market maker offers to sell an asset to other traders.
Bid: the price of an asset for a buyer (will almost always be lower than the offer price).
Spread: the difference between the bid and offer price quoted for an asset, from which market makers make a profit.
PnL: how traders refer to the daily change to the value of their trading positions at the current market price; refers to Profit and Loss.
The role of Flow traders
Flow traders actively take part in market making, making use of this opportunity to profit from the bid-offer spread while providing liquidity to the market. Profit and loss are created by traders when executing these trades.
The role of Agency traders
Agency traders execute trades on behalf of the firm’s clients (usually high volume, followed by a high commission). When executing an order on the behalf of institutional clients, traders must strategically spread out their orders in smaller volumes that reduce their impact on the market to purchase the desired number of shares at a lower price.
The role of Quantitative traders
Quantitative traders create automatic, rules-based trading algorithms for clients who want to benefit from a low-fee, structured trading product. They get involved in markets with structural trading opportunities where algorithms perform better, especially with those requiring high-frequency trading in order to generate profit.
Types of Asset Classes
Equity represents ownership held by shareholders in an entity, realised in the form of shares. Equity trading requires the analysis of companies using various financial metrics (Discounted Cash Flow (DCF) valuation, P/E ratio, EPS, EV/EBITDA multiple etc).
Fixed-income securities provide returns in the form of fixed periodic payments known as coupons. The most common fixed-income securities are bonds, which are issued by companies and governments to raise capital.
The yield to maturity (YTM) is the rate of return on a bond if it is purchased today for its current price, held through its maturity date, and is paid off in full at maturity. Normally, the yield to maturity is expressed as an annual rate.
Currencies are traded in pairs on the FX market. A currency pair includes a base and a quote currency, such as “USD/GBP”, where USD is the base currency and GBP is the quote currency.
Spot rates are the price a buyer will pay “on the spot” for a foreign currency. The forward rate is the price at which currencies will be exchanged at some given date in the future. The forward rate is used by speculators as well as companies looking to hedge their foreign exchange risk.
Commodities such as metals (copper, iron, etc) or energy-related products (oil and natural gas) can also be traded. In particular, investors view metals as a reliable and dependable form of investment because they tend to retain their value over time. Precious metals such as gold are often used as a hedge against inflation and currency depreciation.
Commodities are usually traded using derivatives (explained below), especially through futures or options contracts. For example, Crude Oil WTI (NYM $/bbl) Front Month involves a future toward crude oil.
A derivative is a type of investment that derives its value from the value of other assets like stocks, bonds, commodities, or market index values (S&P 500, FTSE 100, etc). Some derivates involve futures contracts, forward contracts, call options, put options, etc.
For instance, a call option gives the holder the right to purchase an asset for a specific price on or before a specified expiration date. Contrastingly, a put option gives the holder the right to sell an asset for a specified price on or before a specified expiration date.
Examples of Trading Strategies
There are different trading strategies that investors can use to generate returns from financial markets. Here are some examples of some of the most commonly used trading strategies:
Global Macro: Global macro trading strategies aim to take advantage of macroeconomic trends and events such as changes in interest rates, GDP growth, and geopolitical events. These strategies usually involve making large directional bets on financial markets, such as currencies, bonds, and commodities.
Directional: Directional trading strategies involve taking a bullish or bearish position on a specific security or market. This involves buying or selling stocks, options, or futures contracts. Directional traders look to profit from market trends and movements, such as bull markets or bear markets.
Event-Driven: Event-driven trading strategies seek to take advantage of specific events, such as mergers and acquisitions and corporate reorganizations. These strategies involve analyzing company-specific events and making trades based on the expected outcome.
Relative Value: Relative value trading strategies involve taking advantage of price differences between assets. This can involve buying one security and selling another that is related to it, or making trades that exploit differences in interest rates and yield curves.
Statistical Arbitrage: Statistical arbitrage strategies involve using statistical analysis and mathematical models to identify mispricings in financial markets. This can involve taking positions in securities that are expected to move in the same direction or making trades that exploit differences in the correlation between different assets.
Major S&T event: Bank of Japan (BoJ)'s Yield Curve Control
The BoJ's monetary policy targets short-term interest rates at -0.1% and the 10-year government bond yield at 0.5% to consistently achieve its goal of 2% inflation. After years of bond buying and quantitative easing failed to meet this persistent inflation target, the BoJ implemented negative short-term rates since January 2016 to keep the value of the Japanese yen low. To increase long-term rates back again, the BoJ adopted Yield Curve Control (YCC) eight months later by adding a 0% target for 10-year bond yields to its -0.1% short-term rate target. The idea was to control the shape of the yield curve to suppress short, and medium-term yield rates. This would not decrease long-term yields by much while impacting corporate borrowers and reducing returns for pension funds and life insurers.
Figure 1: USD/JPY chart, January 2023 (source: Tradingview)
The adoption of this policy formulated a popular trade idea for FX traders due to the following rationale: the Japanese yen would appreciate against the dollar in the near future as the BoJ would eventually have to stop yield curve control due to market pressure. However, the BoJ's recent decision was completely opposite to the common trade rationale. During the meeting held on January 18th 2023, BoJ announced that it would continue the Yield Curve Control, enhancing its fund supply to make it even easier to control the yield curve. This announcement had a significant impact on the market as it meant a depreciation of JPY compared to the USD, boosting the USD/JPY index from 128 to 131 within a short time frame.