Proprietary trading

Short description: Practice of trading financial instruments using a firm's own money

Proprietary trading (also known as prop trading) occurs when a trader trades stocks, bonds, currencies, commodities, their derivatives, or other financial instruments with the firm's own money (instead of using depositors' money) in order to make a profit for itself.[1] Proprietary trading can create potential conflicts of interest such as insider trading and front running.[2][3][4]

Proprietary traders may use a variety of strategies such as index arbitrage, statistical arbitrage, merger arbitrage, fundamental analysis, volatility arbitrage, or global macro trading, much like a hedge fund.[5] Many reporters and analysts believe that large banks purposely leave ambiguous the proportion of proprietary versus non-proprietary trading, because it is felt that proprietary trading is riskier and results in more volatile profits.

## Contents

* 1 Arbitrage
* 2 Conflicts of interest
* 3 Famous traders
* 4 Notable proprietary trading firms
* 5 See also
* 6 References

## Arbitrage

One of the main strategies of trading, traditionally associated with banks, is arbitrage. In the most basic sense, arbitrage is defined as taking advantage of a price discrepancy through the purchase or sale of certain combinations of securities to lock in a market-neutral profit. The trade will remain subject to various non-market risks, such as settlement risk and other operational risks. Investment banks, which are often active in many markets around the world, constantly watch for arbitrage opportunities.

One of the more-notable areas of arbitrage, called risk arbitrage or merger arbitrage, evolved in the 1980s. When a company plans to buy another company, often the share price of the buyer falls (because the buyer will have to pay money to buy the other company) and the share price of the purchased company rises (because the buyer usually buys those shares at a price higher than the current price). When an investment bank believes a buyout is imminent, it often sells short the shares of the buyer (betting that the price will go down) and buys the shares of the company being acquired (betting the price will go up).

## Conflicts of interest

There are a number of ways in which proprietary trading can create conflicts of interest between a bank's interests and those of its customers.[2]

As investment banks are key figures in mergers and acquisitions, it is possible (though prohibited) for traders to use inside information to engage in merger arbitrage. Investment banks are required to have a Chinese wall separating their trading and investment banking divisions; however, in recent years, especially since the Enron scandal, these have come under closer scrutiny. One example of an alleged conflict of interest can be found in charges brought by the Australian Securities & Investments Commission against Citigroup in 2007.[3]

Another source of conflicts of interest is potential front running, in which case the buy-side clients suffer from significantly higher trading costs. Front running per se is illegal, but there are circumstances under which a broker that operates a proprietary trading desk gains advantage over its clients based on inferences from order book data.[4]

## Famous traders

Famous proprietary traders have included Ivan Boesky, Steven A. Cohen, John Meriwether, Daniel Och, and Boaz Weinstein. Some of the investment banks most historically associated with trading were Salomon Brothers and Drexel Burnham Lambert. Trader Nick Leeson took down Barings Bank with unauthorized proprietary positions. UBS trader Kweku Adoboli lost $2.2 billion of the bank's money and was convicted for his actions.[6][7][8]

Armin S, a German private trader, sued BNP Paribas for 152m EUR because they sold to him structured products for 108 EUR each which were worth 54 00 EUR.[9]

## Notable proprietary trading firms

* Akuna Capital
* Citadel Securities
* DRW Trading Group
* Flow Traders
* Headlands Technologies
* Hudson River Trading
* IMC Financial Markets
* Jane Street Capital
* Jump Trading
* Optiver
* Quantlab
* Squarepoint Capital
* Susquehanna International Group
* Tower Research
* Tradebot
* TransMarket Group
* Virtu Financial
* XTX Markets

## See also

* Flow trading

## References

1. ↑ Heather Stewart (21 January 2010). "What is 'proprietary trading'?". The Guardian. https://www.theguardian.com/business/2010/jan/21/proprietary-trading-wall-street-banks.
2. ↑ 2.0 2.1 Pitt, Harvey L. (2005-02-22). "Conflict of Interest Lessons From Financial Services". Compliance Week. http://www.complianceweek.com/blogs/harvey-l-pitt/conflict-of-interest-lessons-from-financial-services. Retrieved 2014-10-11.
3. ↑ 3.0 3.1 Johnston, Tim (2007-03-23). "Citigroup challenges Australian commission's conflict of interest ruling". New York Times. https://www.nytimes.com/2007/03/23/business/worldbusiness/23iht-citigroup.5002690.html.
4. ↑ 4.0 4.1 "A Front-Running Smile?". Traders Magazine. 26 May 2005. https://www.tradersmagazine.com/news/a-front-running-smile/. "A broker who operates a proprietary trading desk can significantly increase the buyside's implicit trading costs. In the past couple of years, some investment banks' quarterly gains from principal trading alone have approached $1 billion. In certain cases, the assets of individual bank's hedge funds have exceeded the combined assets of all of the bank's customers."
5. ↑ "Proprietary Trading: What It Is & Related Trading Firms". DayTradeTheWorld. 28 September 2020. https://www.daytradetheworld.com/trading-blog/proprietary-trading-your-complete-guide/.
6. ↑ [Kweku Adoboli jailed for fraud over £1.4bn UBS loss "Kweku Adoboli jailed for fraud over £1.4bn UBS loss"]. Kweku Adoboli jailed for fraud over £1.4bn UBS loss.
7. ↑ dzawu, moses (22 January 2020). "After Losing $2.3 Billion at UBS He Now Seeks Redemption in Ghanaian Bonds". Bloomberg.com. https://www.bloomberg.com/news/articles/2020-01-22/fallen-ubs-trader-adoboli-seeks-redemption-in-bond-market-deals.
8. ↑ dalton, samantha (20 November 2012). "Kweku Adoboli: From 'rising star' to rogue trader". BBC News. https://www.bbc.com/news/uk-19660659.
9. ↑ Binham, Caroline (2018-12-20). "BNP failed to book traders in Germany for a week". https://www.ft.com/content/a9e8b574-22f0-11e8-ae48-60d3531b7d11.

* v
* t
* e

Hedge funds

Investment
strategy|

| Arbitrage /
relative value|

* Capital structure arbitrage
* Convertible arbitrage
* Equity market neutral
* Fixed income arbitrage / fixed-income relative-value investing
* Statistical arbitrage
* Volatility arbitrage

|

Event-driven|

* Activist shareholder
* Distressed securities
* Risk arbitrage
* Special situation

Directional|

* Convergence trade
* Commodity trading advisors / managed futures account
* Dedicated short
* Global macro
* Long/short equity
* Trend following

Other|

* Fund of hedge funds / Multi-manager

Trading|

* Algorithmic trading
* Day trading
* High-frequency trading
* Prime brokerage
* Program trading
* Proprietary trading

Related
terms|

| Markets|

* Commodities
* Derivatives
* Equity
* Fixed income
* Foreign exchange
* Money markets
* Structured securities

|

Misc|

* Arbitrage pricing theory
* Assets under management
* Black–Scholes model (Greeks: delta neutral)
* Capital asset pricing model (alpha / beta / security characteristic line)
* Fundamental analysis
* Hedge
* Securitization
* Short
* Taxation of private equity and hedge funds
* Technical analysis

Investors|

* Vulture funds
* Family offices
* Financial endowments
* Fund of hedge funds
* High-net-worth individual
* Institutional investors
* Insurance companies
* Investment banks
* Merchant banks
* Pension funds
* Sovereign wealth funds

Regulatory|

* Fund governance
* Hedge Fund Standards Board

* Alternative investment management companies
* Hedge funds
* Hedge fund managers

* v
* t
* e

Financial markets

Types of markets|

* Primary market
* Secondary market
* Third market
* Fourth market

Types of stocks|

* Common stock
* Golden share
* Preferred stock
* Restricted stock
* Tracking stock

Share capital|

* Authorised capital
* Issued shares
* Shares outstanding
* Treasury stock

Participants|

* Broker-dealer
* Day trader
* Floor broker
* Floor trader
* Investor
* Market maker
* Proprietary trader
* Quantitative analyst
* Financial law
* Regulator
* Stock trader

Exchanges|

* Electronic communication network
* List of stock exchanges
* Trading hours
* Multilateral trading facility
* Over-the-counter

Stock valuation|

* Alpha
* Arbitrage pricing theory
* Beta
* Bid–ask spread
* Book value
* Capital asset pricing model
* Capital market line
* Dividend discount model
* Dividend yield
* Earnings per share
* Earnings yield
* Net asset value
* Security characteristic line
* Security market line
* T-model

Trading theories
and strategies|

* Algorithmic trading
* Buy and hold
* Contrarian investing
* Day trading
* Dollar cost averaging
* Efficient-market hypothesis
* Fundamental analysis
* Growth stock
* Market timing
* Modern portfolio theory
* Momentum investing
* Mosaic theory
* Pairs trade
* Post-modern portfolio theory
* Random walk hypothesis
* Sector rotation
* Style investing
* Swing trading
* Technical analysis
* Trend following
* Value averaging
* Value investing

Related terms|

* Block trade
* Cross listing
* Dark pool
* Dividend
* Dual-listed company
* DuPont analysis
* Efficient frontier
* Flight-to-quality
* Government bond
* Haircut
* Initial public offering
* Long
* Margin
* Market anomaly
* Market capitalization
* Market depth
* Market manipulation
* Market trend
* Mean reversion
* Momentum
* Open outcry
* Position
* Public float
* Public offering
* Rally
* Returns-based style analysis
* Reverse stock split
* Share repurchase
* Short selling
* Slippage
* Speculation
* Stock dilution
* Stock exchange
* Stock market index
* Stock split
* Trade
* Uptick rule
* Volatility
* Voting interest
* Yield

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