Equity Trading: The Definitive Guide

Ask the average person what someone does on “Wall Street,” and he/she will probably describe equity trading, AKA buying and selling stocks.

If this person then discovers that you work on Wall Street, he/she will proceed to ask you for “hot stock tips” next.

The irony is that most people at large banks have jobs that are unrelated to trading stocks.

But that image persists, and many students become interested in equity trading (also called equity sales & trading by those in the biz) as a result.

In today’s article, we’ll look at recruiting, different desks, and the future of the industry – but let’s start with a quick job description:

Equity Trading: A Quick Job Description

Investment banks divide their “Markets” groups into two main areas: 1) Equities and 2) Fixed Income, Currencies & Commodities (FICC).

Equity Trading deals with companies’ stocks and their derivatives.

Derivatives are financial instruments whose values are based on an underlying asset, such as a specific company’s stock or an index of stocks.

The simplest type is the option, which gives you the right but not the obligation to buy or sell a specified amount of the underlying asset at a specified price within a specified time frame.

FICC is much broader than Equities and includes “everything other than stocks”: Corporate and government bonds, credit-related derivatives, structured credit products, currencies, commodities, and more.

In both areas, banks make money from agency trades and making markets for clients.

An “agency trade” means that the trader executes an institutional investor’s order, such as buying 100,000 shares of Company X at the market price, and earns a small fee for it.

“Making a market,” by contrast, means that the trader helps a client buy or sell securities at a price that both sides agree upon.

For example, let’s say that you work in equity trading at a large bank.

A hedge fund professional might call your bank, ask to buy 1 million shares of a particular company’s stock, and see what price you can offer.

This professional calls your bank because he wants to buy all 1 million shares at a specific price.

The stock’s current market price is $100, and you, the equity trader, say that you’re willing to buy shares at $99 and sell shares at $101. This $99 – $101 is the “bid-ask spread.”

The hedge fund trader like this price of $101, so he places the trade with you.

You are now “short” 1 million shares at $101 because you’ve sold the shares at that price before you’ve purchased them.

To make money with this risk trade, you’ll now have to buy 1 million shares for less than $101.

It’s not as simple as buying all 1 million shares right away for the current price of $100 – if you do that, you will almost certainly drive the share price up, and your profits might disappear.

So, as a trader, you must divide this task into smaller pieces and buy portions from different parties over time to profit from the trade.

Of course, that’s not the whole story because the client will also pay commissions to make this trade.

So, even if you lose money on the buying and selling, you might still complete this trade if the commissions and fees offset the loss.

In addition to agency trades and market making, a long time ago banks used to have proprietary trading groups that used firms’ own money to profit from “directional bets,” i.e., betting on stock prices going up or down.

However, the Volcker Rule in the aftermath of the 2007 – 2008 financial crisis banned most prop trading at large banks in the U.S.

If you want to make money on directional bets in the current environment, you’ll have to work at a prop trading firm or hedge fund instead of a bank.

As of 2018, there are some signs that the U.S. government may be attempting to weaken the Volcker Rule.

But even if that happens, most prop trading will happen at non-banks for the foreseeable future.

The Equity Sales Job Description

We focused on trading in the description above, but the other side of sales & trading is sales.

Trading is about the execution of buy/sell orders and making markets for clients, while sales is about pitching ideas to clients and getting them to trade in the first place.

Salespeople spend the day speaking with clients and presenting ideas from the research division, and at night, they attend client dinners and events to continue building relationships.

They must have a solid understanding of the securities they sell, but they do not need to be experts on the math or execution.

If you’re an outgoing, social person who also likes the financial markets, you could do well in sales; if you prefer math and quick thinking, trading is a better fit.

You can learn more about sales in this article on an equity sales internship and this one on an equity derivatives sales internship.

Will Equity Trading Get Automated or Displaced?

We receive a lot of questions about the future of sales & trading, and especially whether or not equity trading will be completely automated.

The short answer is that much of it already has been automated.

For example, Goldman Sachs used to have ~600 traders on its cash equities trading desk in 2000, but by 2017, that had shrunk to…. 2.

Goldman is also launching a “Marquee” trading platform in the U.K. that will automate even more of the process.

You see a lot of stories about cash equities desks (i.e., groups that buy and sell normal stocks) disappearing because the product is simple, there’s a ton of liquidity, and there’s a lot of data for algorithms to work with.

By contrast, complex products that have barely any liquidity are less likely to be automated because there’s little data.

That means:

• You should gain programming knowledge if you want to work in S&T but give yourself more career options – such as writing the program that automates your job.
• If you don’t want to program, learn about data mining and data science, which will also make a huge impact on the industry.
• If you want to reduce the risk of losing your job, you should work on a desk that trades more complex products with less liquidity, such as exotics.

It’s unlikely that equities sales & trading will disappear, but it will become even more technology-driven in the future.

How to Become an Equity Trader: Recruiting and Interview Questions

In the U.S., you’ll go through an online application, video interview, and Superday for both sales and trading roles because they’re part of the same rotational program.

In the U.K., you’ll complete an assessment center in place of the Superday, which we covered in a separate article on the rates trading desk.

The questions in the video interview tend to be generic: Tell me about yourself, tell us about your teamwork/leadership experience, discuss a current event in the markets, or explain which S&T product you are most interested in.

You’ll usually receive 4-5 questions, and you’ll get 30 seconds to prepare an answer for each question and 2-3 minutes to record your answer.

If you pass that round and make it to the Superday, you’ll go through 5-10 one-on-one or two-on-one interviews with professionals at all levels from different desks within S&T.

They’ll ask more in-depth questions, but the topics will be similar: Your story, leadership/teamwork experience, stock pitches, and how you might work with clients.

We published a series on sales & trading interview questions and answers, so you should refer to that for more details (see the technical guide here).

To summarize those articles:

• You are more likely to get brainteasers, math questions, and product-specific questions (e.g., explain the Greeks) if you say that you’re interested in trading; if you say you’re interested in sales, you’ll get more “How would you handle Problem X with Client A?”-type questions.
• The best way to set yourself apart in interviews is to develop in-depth knowledge of a specific product the group trades. For example, learn a lot about an exotic equity derivative, such as barrier options or rainbow options, so you can then discuss strategies related to the product.
• You need a good handle on math, and programming knowledge is helpful, but you don’t need to be a math wizard. Trading is more about applying your knowledge and making quick decisions under pressure than it is about deriving Black-Scholes from Ito’s Lemma.

Equity Trading Desks: What to Expect

Most S&T desks are split into cash vs. derivatives vs. exotics, and this same split applies to equities sales & trading.

“Cash” here means normal company stocks, “derivatives” refers to call and put options on stocks, and “exotics” refers to derivatives that are more complex than simple options.

You can further divide those into sales, trading, and sales-trading.

We won’t cover every group and sub-group, but here are a few of the main teams:

Cash and Derivative Sales

This role is similar to the sales job described above: You pitch clients on possible trade ideas that involve stocks, options, and variations of those.

You’ll also help the bank place IPOs and follow-on issuances that the equity capital markets division is underwriting.

The key skill in this area is your ability to synthesize huge amounts of information into a concise, 1-2-minute pitch that convinces the client to trade with you.

Each time a trade is placed, you earn a commission, which is split between different groups in S&T.

The job continues after the market closes and you leave the office because you’ll have to attend client dinners and other events at night.

Cash Sales-Trading

“Sales-Trading” is the execution side of sales.

Sales-Traders still pitch ideas to clients, but the ideas are geared toward short-term execution instead of longer-term strategies.

Unlike normal traders, Sales-Traders do not take any risk – they simply execute agency trades.

So, for example, Sales-Traders would not be involved with that example in the beginning about the hedge fund purchasing 1 million shares at $101.

Sales-Traders would only be responsible for executing that order “at market prices” without taking a long or short position that needs to be unwound.

To do well in this role, you must be good at quickly coming up with trade ideas that interest clients instead of pitching the fundamental-oriented ideas that salespeople might present.

Since the role involves client relationships as well as quick thinking based on market news, it is somewhere in between Sales and Trading and is labeled as such.

Cash Trading

Professionals in this area do what we described in the beginning: They buy and sell shares for clients and make markets in companies’ stocks.

Unlike Sales-Traders, the Traders here complete both agency trades and risk trades (the hedge fund trade described earlier).

The most important skill on this desk is market instinct: You need to be good at mental arithmetic, and you must react quickly to events and major happenings.

This area has been automated at banks because bid-ask spreads are very low, the fee/commission potential is low, and the trading processes are relatively simple.

So, you might do well here if you’re a programmer, you’re interested in the financial markets, and you want to find ways to optimize trading algorithms.

But if you want to be an actual trader, you’d be far better off on other desks.

Flow Derivatives Trading

On this desk, you trade “vanilla derivatives,” primarily options, which are in between cash equities and exotics regarding complexity and liquidity.

Using simple call and put options, you can create more complex strategies, like the straddle (buying a call and put option at the same strike price, which gives you a positive payout if the stock moves up or down by a certain amount by option expiration).

There are dozens of other strategies with colorful names, like the butterfly, the iron condor, and the strangle.

And then there are also index options and Delta One products (derivatives with linear, symmetric payoff profiles, such as equity swaps).

Some banks also put convertible bonds in this team, but it’s a separate group at other firms.

Options trading is far more complex than stock trading because there are more variables and relationships to track.

With stocks, the price is the main variable that changes – but with options, there’s the price, passage of time, implied volatility, realized volatility, dividends, interest rates, and others.

To learn more, read up on “the Greeks,” which measure the rate of change of the option’s value relative to the stock’s price, volatility, the passage of time, interest rates, and other factors.

You might be correct about several variables but still lose money on a trade because one parameter changed dramatically.

If you want a flavor of this job, check out our “Day in the Life of an Options Trader” article.

It’s a bit like the guy at the circus who tries to spin eight plates at once: He starts with everything, but by the time plate #4 or #5 start spinning, he has to go back and adjust plate #1.

This desk requires a mix of quantitative ability and market instinct.

You don’t need to solve partial differential equations in your head, but you do need to make more calculations than cash equities traders.

The challenge is that you need to multi-task very well and act quickly because the options market is highly liquid.

Traders here make money from the bid-ask spread as well, but it’s not as simple as comparing prices because you can also profit based on volatility and other factors.

The headcount in Equity Derivatives has declined over time, and it has become more automated, but there’s still more of a human element than there is in Cash Equities Trading.

Exotics Trading

Exotics are the most mathematically complex and least liquid of all the products within Equities.

If you work in this group, you create and price these structures for clients and then manage the hedges once a deal is complete.

You often hedge the risks of the transaction with plain-vanilla structures, such as normal options or equities.

There is no precise, universal definition of “exotics,” but some people define them as derivatives that have more features than just a strike price and expiration date.

Examples include:

• Barrier Option: The option becomes “activated” only if the underlying stock’s price reaches a certain level.
• Cliquet: A series of at-the-money options where another option starts when one ends; effectively, it’s an option with a readjusting strike price.
• Compound Option: An option on another option – so it has two strike prices and two expiration dates.
• Binary Option: It pays nothing or a fixed value.
• Lookback Option: The payoff is determined at the end of the option’s life, and it is based on the maximum value of the underlying asset during the period minus the strike price.
• Rainbow Option: An option on the best or worst performer of several underlying securities.

These are just the basics; the structures can get far more complex because they’re often created to serve a client’s specific needs.

There is very little liquidity for most of these products, so you focus on the pricing behind them.

That means more intensive analysis and simulations than traders on other Equities desks, though you’re still not solving PDEs all day.

Exotics is all about nuances and small details that can make or lose a lot of money, so you must have outstanding attention to detail and a serious quantitative background for this desk.

The Sales & Trading Career Path from Intern to Managing Director

As an intern, you’re not allowed to trade or speak directly with clients, so much of your work will be shadowing traders and salespeople; please see our “Day in the Life of a Sales & Trading Intern” article for coverage.

You’ll assist the full-timers by creating tools that save them time, running errands, and doing work that keeps slipping off their “to-do” list.

As an Analyst, you’ll start out doing similar work to assist the senior traders and salespeople, and gradually you will be granted more trading/client responsibility if you perform well.

Your risk limits will increase over time so that you can make more aggressive trades with higher potential payoffs.

The day-to-day role will not necessarily change that much as you move from Analyst to Associate to VP to Director to Managing Director unless you move to the managerial side and stop trading actively.

That path offers less “career volatility,” but it also means a lower chance of an outsized bonus if your team performs well.

Equity Trader Salaries, Options Trader Salaries, and Derivatives Trader Salaries

Compensation for traders and salespeople is highly variable since so much of it is linked to your performance.

But as of 2018, you can expect the following rough ranges for traders at bulge-bracket banks in New York:

• Analyst: $75K – $100K Base Salary; $125K – $150K Total Compensation
• Associate: $100K – $125K Base Salary; $150K – $200K Total Compensation
• VP: $150K – $200K Base Salary; $250K – $500K Total Compensation
• SVP / Director: $180K – $250K Base Salary; $450K – $1,000K Total Compensation
• EVP: $250K – $350K Base Salary; $650K – $1,200K Total Compensation
• MD: $350K – $400K Base Salary; $1,500K+ Total Compensation

Traders typically earn 15-20% more than salespeople, so you should discount these figures appropriately if you’re on the sales side.

Sources for This Data:

• Selby Jennings – Detailed Presentation on S&T Compensation
• Michael Page – Front-Office Salary Report (pg. 8) (You can Google to find newer versions)
• Emolument – Sales & Trading Compensation

Keep in mind that you will receive only a small portion of your bonus in Cash as you move up the ladder – an MD-level trader might get only ~20% in cash, with the rest in stock and deferred compensation.

That is one major disadvantage of working at the large banks: Cash compensation at the senior levels is much lower than it is at prop trading firms or hedge funds.

Equity Sales & Trading Exit Opportunities

Most traders stay in trading, move to a hedge fund or asset management firm, or join a prop trading firm.

The skill set you develop in trading isn’t so useful in roles like private equity, corporate finance, or corporate development, so your exit options are more limited than in investment banking.

You can move into an execution trading role at many types of hedge funds, but it’s trickier to win investment-analyst-to-Portfolio-Manager-track roles because you’ll also need fundamental analysis skills for those jobs.

Many traders move to global macro hedge funds, but if you work in Equities, you tend to focus on “micro” analysis – so you might not fit in as well at those funds.

To maximize your potential exit opportunities, avoid the Cash Equities desk – as we’ve been recommending – as well as specialized products where fundamental analysis is not required.

Derivatives desks tend to be good for exit opportunities, and many desks on in Fixed Income Trading also work well because they’re macro-oriented.

You’ll likely need 2-3 years of experience and 6-12 months of managing your own book to move into a buy-side role. If you want to do so, you should make a move sooner rather than later (e.g., after 2-4 years rather than 5-7 years) because there’s little benefit to waiting.

For more details, please see our articles on the hedge fund industry and the hedge fund career path.

If you’re really ambitious and want to know how to start a hedge fund, check out our article on the topic; the short answer is you won’t be able to do it without significant experience at a hedge fund first.

If you work in sales rather than trading, you will get broader, but slightly different exit opportunities.

For example, you could join the sales team at a normal company, or you could move into fields like investor relations that are relationship-oriented.

You’re not likely to win an investing or execution trading role at a hedge fund, but you could join in a fundraising or investor relations role.

Is Equity Trading Right for You?

Banks divide sales & trading into Equities and FICC, but it’s best to think about your ideal desk in terms of micro vs. macro analysis.

Equities sales & trading is more geared toward “micro” (individual company) analysis, so if you’re interested in trading derivatives based on companies’ stocks, it could be a good fit for you.

It could also be a good fit if you’re more interested in the math/programming side and you want to work on technology to automate the job, or if you want to work with complex products such as exotics.

On the sales side, it depends on the product(s) you’re most interested in pitching to clients; if you’ve always followed individual companies, Equities or Equity Derivatives could work well.

Just don’t tell anyone exactly what you do, or you’re guaranteed to get that annoying question about “hot stock tips” at your next family gathering.