Prop Shops and Trading Schools Raise the Bar
Stocks, Futures and Options, January, 2004

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"The good companies are looking for trading ability, quantitative analysis ability and a modicum of programming ability," Norman says. "What we're seeing then, is that trading firms no longer have a stranglehold on their traders. Instead, they treat them like autonomous entities within their organization. And with risk measures in place, firms let the traders do their own thing."

Leap into Futures
While the interest level in becoming a successful stock trader is rather muted, proprietary trading firms that focus on trading futures are popping up rapidly in Chicago. Some firms are continually recruiting traders to trade contract such as Bund futures on Eurex, E-mini S&P 500 futures on the Chicago Mercantile Exchange or interest rate contracts on the Chicago Board of Trade. And like their equity trading counterparts, futures prop trading firms often choose applicants with little or no trading experience.

Jeff Quinto, managing member of Altea Trading in Chicago, says it is difficult to predict who will be a good trader. "We have a steady stream of people who arrive at our door, but the hard part is, which of these people are going to make it?" Quinto says. "We want them to have some experience in financial markets such as a clerk on the floor, or someone who has traded stocks and is competitive in nature. We've found that if they are overly analytical or may be the world's foremost expert on technical trading, they actually may or may not be such a great trader. You need people who will focus their entire energy on the price right at this second. That's a very special person."

Once inside, Quinto says the goal for traders is to make money on four out of five trading days. That said, Quinto emphasized that traders are encouraged to go with a style that works for them. "We want to provide an environment where they can be successful. Some people will be more aggressive, some less aggressive, more consistent or less consistent and still be successful traders. We try to recognize that and put them in the context of the way risk should be handled and fit them within a risk profile we think makes sense."

John Herron, trading manager for Arcar Trading in Chicago, opened a prop trading firm in October with 12 traders. The company hopes to expand that number to about 30 over the next year. Arcar hired a mix of experienced traders with newcomers, but hopes to build its staff with novices who can be taught how to trade.

"My view is that you train traders to be traders, so you give them a wide general knowledge of the industry," Herron says. "We go into technique, psychology, understanding the mathematics and functions of the financial markets. That process can take several months, but after one month they can start to trade lightly."

Herron's group focuses its trading mostly on European markets, particularly Eurex, which aims to open a U.s.-based exchange in February if they receive approval in time. "The European markets move or trend quite well, with good volatility and great liquidity," Herron says. "And they are cheaper to trade than the Chicago exchanges."

Meanwhile, Geneva Trading in Chicago is expanding its business strictly from a proprietary trading s hop into a training facility for new traders sometime during the first quarter. Geneva will continue to run a dual proprietary trading operation in Chicago and Dublin, but found strong demand for an educational program. Mary McDonnell, CEO of Geneva, says the class sizes will be no more than a dozen at a time and will last eight to 12 weeks. Fees were not yet decided for the courses, but will be taught by the same instructors used to teach its methodology to its proprietary traders.

Growing Up
While proprietary trading firms are nothing new to equity or futures markets, executives in both industries say they expect the size and number of operations to grow in the coming year. Schonfeld believes that jaded retail traders will return, especially if the market shows steady gains in the coming months. If that occurs, it means more opportunity for the pros.

"We're looking to grow our proprietary trading and retail side," Schonfeld says. "You can blame it on a decimalization, bear markets or lack of volatility. But if you look at a trader's performance and variables, the number one variable that will make it better is retail volume coming back into the market. And they will absolutely be back in the market."

On the futures side, firms are convinced that proprietary trading will continue to grow along side the string of record volume years at the exchanges. "We really believe we are in an embryonic stage of financial markets and in the initial phase of this proprietary trading trend," Herron says.

Norman echoes that sentiment, especially with the continued expansion of electronic trading across all markets. And proprietary firms in the coming months and years may be a virtual network of traders, trading from their homes around the country.

"The trend is definitely toward a distributed marketplace," Norman says. "Traders are becoming more professional and so is their support. And now you're getting a number of traders who are working from home or outside the central office, and that never used to be the case in Chicago. But now, because of the high quality of interaction between the trader, company, risk managers and the marketplace, they can trade from anywhere in the world."

Ultimately, the step from active trader to proprietary trader is a huge one. Some may shy away from the industry because of the numerous scams and fees that make proprietary trading undesirable, if not unprofitable for the trader. But others say good firms open doors for traders and enable them to maximize their true trading potential.

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