how do prop desks make money in a very efficient market
how do prop desks make money in a very efficient market
In the efficient boglehead market, does the avg. wall st. prop desk have the ability to beat the market over the long run? Do the CEO's of these large firms honestly think they can beat the market without cheating? Or are there enough grey areas like front-running, for them to be profitable?
Or perhaps the market isn't as efficient as B-Schools tended to teach.
I personally believe Buffet had it right: “In the short run, the market’s a voting machine and sometimes people vote very non-intelligently. In the long run, it’s a weighing machine and the weight of business and how it does is what affects values over time.”
This short term "voting machine" behavior gives proprietary trading desks the opportunity to beat the market in the short term.
This does not however invalidate the boglehead philosophy. With our (relatively) small portfolios, it is unlikely we'd be able to beat the market long term net of taxes, trading, management and research costs.
I personally believe Buffet had it right: “In the short run, the market’s a voting machine and sometimes people vote very non-intelligently. In the long run, it’s a weighing machine and the weight of business and how it does is what affects values over time.”
This short term "voting machine" behavior gives proprietary trading desks the opportunity to beat the market in the short term.
This does not however invalidate the boglehead philosophy. With our (relatively) small portfolios, it is unlikely we'd be able to beat the market long term net of taxes, trading, management and research costs.
Sure, plenty of evidence that some endowments, hedge funds, prop trading desks "beat the market" (for lack of a better term) over some periods of time. The ones that do become big and famous, the ones that don't you never heard of. They're supposed to limit their value at risk, so when they guess wrong they don't take down the company. Sometimes (eg Lehman) they fail to do this.
Does this prove that all markets aren't totally efficient all the time? Sure, especially illiquid ones.
But that's a far cry from saying you (or the average broker or mutual fund manager) can consistently guess which stocks are headed in which direction.
That's why Swensen's first book (for institutions) is about beating the market, while his second (for individual investors) is about tracking it.
Is there cheating going on? Certainly, look at the recent insider trading arrests. But there's a probably more "grey area" activity (eg Sokol gets to meet with the CEO of Lubrizol). There's also plenty of good old fashion market beating.
Nick
Does this prove that all markets aren't totally efficient all the time? Sure, especially illiquid ones.
But that's a far cry from saying you (or the average broker or mutual fund manager) can consistently guess which stocks are headed in which direction.
That's why Swensen's first book (for institutions) is about beating the market, while his second (for individual investors) is about tracking it.
Is there cheating going on? Certainly, look at the recent insider trading arrests. But there's a probably more "grey area" activity (eg Sokol gets to meet with the CEO of Lubrizol). There's also plenty of good old fashion market beating.
Nick
Re: how do prop desks make money in a very efficient market
No.usnaron wrote:In the efficient boglehead market, does the avg. wall st. prop desk have the ability to beat the market over the long run?
I don't know. But as markets aren't particularly efficient - especially in the short run - it probably doesn't matter.usnaron wrote:Do the CEO's of these large firms honestly think they can beat the market without cheating?
In efficient markets, no. In real markets, probably, though I (personally) wouldn't consider front-running a grey area.usnaron wrote:Or are there enough grey areas like front-running, for them to be profitable?
Simplify the complicated side; don't complify the simplicated side.
- wintermute
- Posts: 229
- Joined: Mon Mar 15, 2010 10:36 pm
They're the ones who make it efficient. They have way more resources than an individual investor. Several employees can research a single stock, and utilize all the data, models, and inside info they have available. There's also the latency and other advantages their HFT systems have (like getting their "erroneous" trades canceled and receiving volume rebates).
There are opportunities there, but to really exploit them is a full-time job for many people and requires a lot of money.
Small investors do have the advantage of not moving the market in small/micro caps, like big funds run into, tho.
There are opportunities there, but to really exploit them is a full-time job for many people and requires a lot of money.
Small investors do have the advantage of not moving the market in small/micro caps, like big funds run into, tho.
I think there must always be some amount of inefficiency, but it is very small.
If there was large inefficiency then there would be many smart people rushing to exploit it, and this would drive down inefficiency. However, if inefficiency goes to zero then there would be no incentive for anyone to seek out any information or do any research, and inefficiency would start to rise.
There must be an equilibrium, and in equilbrium only players who are the most efficient gatherers of relevant information will still be in the game....the others will drop out, or they will find a way to extract money from less knowledgable investors through commissions and fees.
I think the evidence shows the market is extremely close to efficient, but there may be some trading desks with a small edge in terms of their information costs which allow them to earn a profit.
If there was large inefficiency then there would be many smart people rushing to exploit it, and this would drive down inefficiency. However, if inefficiency goes to zero then there would be no incentive for anyone to seek out any information or do any research, and inefficiency would start to rise.
There must be an equilibrium, and in equilbrium only players who are the most efficient gatherers of relevant information will still be in the game....the others will drop out, or they will find a way to extract money from less knowledgable investors through commissions and fees.
I think the evidence shows the market is extremely close to efficient, but there may be some trading desks with a small edge in terms of their information costs which allow them to earn a profit.
The bolded part makes no sense. You've just described an inefficient market. Of course an investor with better resources has an advantage over an investor who doesn't. That's precisely what you'd expect in an inefficient market.wintermute wrote:They're the ones who make it efficient. They have way more resources than an individual investor. Several employees can research a single stock, and utilize all the data, models, and inside info they have available. There's also the latency and other advantages their HFT systems have (like getting their "erroneous" trades canceled and receiving volume rebates).
There are opportunities there, but to really exploit them is a full-time job for many people and requires a lot of money.
Small investors do have the advantage of not moving the market in small/micro caps, like big funds run into, tho.
Darin
Makes sense to me - the hedge funds, in sweeping up that last bit of free lunch, make the markets as efficient as they can be.Drain wrote:The bolded part makes no sense. You've just described an inefficient market. Of course an investor with better resources has an advantage over an investor who doesn't. That's precisely what you'd expect in an inefficient market.wintermute wrote:They're the ones who make it efficient. They have way more resources than an individual investor. Several employees can research a single stock, and utilize all the data, models, and inside info they have available. There's also the latency and other advantages their HFT systems have (like getting their "erroneous" trades canceled and receiving volume rebates).
There are opportunities there, but to really exploit them is a full-time job for many people and requires a lot of money.
Small investors do have the advantage of not moving the market in small/micro caps, like big funds run into, tho.
Nick
A good way to think of efficient market theory is that it's a part of general competition theory. Participants compete against each other to make a profit and this drives price towards fair value. As in any reasonably competitive industry, participants can make a profit. To take a random example, automobile manufacturing is competitive, but some make a lot of money doing it. That Toyota has a big advantage over you doesn't mean it isn't a competitive market.Drain wrote:The bolded part makes no sense. You've just described an inefficient market. Of course an investor with better resources has an advantage over an investor who doesn't. That's precisely what you'd expect in an inefficient market.wintermute wrote:They're the ones who make it efficient. They have way more resources than an individual investor. Several employees can research a single stock, and utilize all the data, models, and inside info they have available. There's also the latency and other advantages their HFT systems have (like getting their "erroneous" trades canceled and receiving volume rebates).
There are opportunities there, but to really exploit them is a full-time job for many people and requires a lot of money.
Small investors do have the advantage of not moving the market in small/micro caps, like big funds run into, tho.
Competition is why prices are the best estimates of value available and why it's hard to beat the market.
Fama did a paper a while back on the issue of whether traders had talent. He concluded that there wasn't enough data to answer the question with statistical significance.
None of this makes any difference for most investors, as they don't have the ability to beat the market or to pick managers who might beat the market. Any rational manager with talent will charge enough to keep the bulk of profits to herself.