Joint Venture

Victor sent us an early edition copy of his new book.

^{(continued from Bitcoin)}

I skipped to my chapter, read a couple pages, and then immediately stopped reading because I just can’t. He also wrote chapters for most of the better Junior Traders on the desk–Eagle, Clockwork, Anton, Saxon plus some other people I didn’t recognize from his speaking tours in South Africa, Singapore, and U.S. college campuses. It was written in a similar tone and style to Two Great Positions–the colorful nicknames and the casual anecdotes on the desk and Victor hyping us up as great traders even though we hadn’t accomplished anything yet.

Just for kicks, here are some fun morsels about us from The Gameplan:

1. One thing I have not really described on the desk is the frattier shenangians that go on. There were pushup contests. Trash talk over fantasy football leagues. Ogling t-shirt models on theChive.com. Cracking beers at the desk. Tuco and Anton were the main perpetrators. There was a whole desk wide debate on what Anton should do regarding his two girlfriends–which he claims had occurred by happenstance, not by intent. So then Tuco comes up with a fake e-mail, summong him for night-time Asian market duties on Valentine’s Day as an excuse to get out of one of his commitments. Speaking honestly as someone who would never be confused as a fratboy… it was all great, I enjoyed the lockerroom talk.
2. Tuco wanted to leave MBC two years ago (2010) because he was burnt out. He still seems burnt out, his PnL wasn’t what it used to be, and at the moment, tensions between him and Avery/Victor has never seemed higher. More on him later.
3. Eagle applied to MBC via Craigslist. According to his cover letter he seemed to have very little prior knowledge of markets compared to us 2011 guys with our retail accounts and college trading clubs. He bought into the MBC training program as much as anyone with diligence and work rate. Him being as good as he is a nice feather in the cap for the firm.
4. Clockwork was once positive for 30 consecutive trading days. Now, that probably includes days where he made between $1-99 but it’s better than losing. That’s why he gets his nickname.
5. Terrance got a quick mention. He didn’t think he could run his algo at MBC and tried to offer Victor constructive criticism on improving the firm. Victor didn’t take kindly to that and nicknamed him “Fail Boy”. I really wish I heard that conversation live because the book only gives you the PG-rated version. Word on the grapevine was that he was out at Chimera in eight months.
6. Victor wanted to pair every chapter with transcribed text from an MBC Tradecast, ideally one that would showcase that individual trader’s skill and setup selection. For me it was the AMRN “Sell the News trade”. But there was one chapter where he included a Tradecast of a mediocre trade on LVS where I vividly remember his palpable disgust at a trader named Koshi. The transcript has a lot of Victor (upset) and Victor (clearly displeased) and then finally, Victor: I don’t even want to continue, this is an awful trade, someone please tell him why. PG-rated of course. So then he asked all us Junior Traders to tear apart Koshi’s analysis. It was classic Victor the Trading Coach™. I felt bad for the Koshi, I’m sure he was trying his best. Experience has since shown me it’s hard to meaningfully deconstruct why a trade is mediocre and the best way to do it is to baseline compare it to actual great trades/edges (which we didn’t really have at the time).

Anyway, that’s all fun and games but what really caught my attention was the first chapter about MBC’s business struggles. To his credit, Victor was quite candid about the hard realities behind the prop industry post-2008. This was the turbulent period for MBC when all the good core traders from the TGP-era left after fighting over profit split and commissions–that’s what happens during leaner times, you gotta fight over the scraps. Many trading firms had to deal with existential questions about their future and this was punctuated by the infamous Schonfeld letter in 2010. Many factors came into play but these were the two main ones: 1) the lack of market volatility since 2008, which daytraders thrive on, 2) the rise of HFT algos in the market, which made scalping and tape-reading much tougher.

Business numbers were a black box to us Junior Traders; we weren’t really in the know about how much things cost for a trading desk. Victor fills us in with this eye-opening sentence: “Even a flat month in P&L can cost 200k plus after fees, expenses, staff, and rent.” None of us were making six figure money and you needed at least a handful of traders who could produce that year over year just to survive. When you contextualize the finances, I guess I couldn’t blame Victor and Avery for squeezing every penny out of the MBC Education Machine. It was their most valuable financial lifeline and they likely reinvested a decent chunk of their commercial revenue to support the MBC Trading Desk.

Tuco lived out in Battery Park, 10 mins away from me, and he’d often invite me to hang at his favorite pub O’Hara’s. Tuco shared with me his regrets that, as head trader, he couldn’t get the desk on track. We were still a bunch of pikers who couldn’t create high upside outcomes. One thing he liked to harp on was that we traded more size but we didn’t actually take on much more risk. It felt kinda fake when we had 10,000 shares on a position but we’d just want to tighten out stops. We didn’t want to take pain. This mindset led us to gravitate back towards stocks that didn’t move with tight consolidation setups. High conviction position trading still wasn’t really a thing for us. It seemed like all his efforts earlier in the year to get us to take “real risk” had stalled out.¹ For those wondering why we didn’t keep pressing AAPL, it just wasn’t as good after the summer for whatever reason He considered our risk-aversion a problem of company culture and he said he had been battling Victor and Avery on the firm’s internal direction and the contents of the training program. Just when it seemed like he was at peak burnout, he then divulged to me that something was in the works for a big change and that it would take the firm in a completely new direction. MBC was going to leave Y5.

Some additional background: MBC’s relationship with the Y5 broker dealer had been rapidly deteriorating. There were two sticking points here: 1) A new rate increase (commission) that Y5 was passing down to all subsidiary trading firms and 2) Y5 had been subject to an SEC investigation and MBC had to shell out on legal fees to answer witness subpeonas and show supplementary documentation despite not even being an actual target of the investigation. Things were not good here. Management felt it was time to explore additional strategic options.

This is pure speculation on my part, but I’d like to think the Spark Merling outburst was the final straw. Spark wasn’t just a trader but also a firm principal at Y5. On top of contentious negiotiations and the way Y5 loved to nickel and dime us, coming in hot the way he did and disrespecting one of our core traders was not acceptable behavior. Who wants to work with a guy like that?²I heard this story about Spark Merling second hand. On a hot and stressful day, Spark once ripped a desk fan from another Y5 trader– “I’m taking this”. The other guy didn’t back down and wanted to give him the business–“If I cut you and you cut me, we both bleed [n-word ending in ‘a’]!” They had to be seperated before coming to blows.

It was time for them to concede the hard realities: Avery, Victor, and Tuco could not support the trading desk on their own. Their low margin, high volume trading strategies from the past could no longer cover the steep operating costs. Now was the time to find the right business partner–one that could offer the support neccesary to succeed like better technology, deeper pockets, and an aggressive let-it-rip attitude on risk. Perhaps the partnering firm would be looking for the one thing MBC could provide in spades: trader education. That would be a good match.

A Firm Out West

Near the end of 2012, friendly meetings had started between MBC and another firm out in Austin, Texas called Western Trading Group (WTG). WTG was led by a man named Mr. West and here’s his story: back in the late 90’s, Mr. West and his partners ran an investment company that was one part broker dealer and one part prop trading group. In 2001, they then sold the BD/technology side of the company to Instinet for $150 million and kept the proprietary trading group that would eventually become WTG. WTG was a prop trading firm that attacked market inefficiencies and thrived on market volatility. According to a company profile story in a local newspaper, WTG traders made over $50 million in 2008. Even in MBC’s heydey, they were not in that PnL ballpark. Not too many people in the finance world knew about WTG but they were the real deal.

WTG had two goals in mind: 1) They wanted to expand into New York, the Mecca of proprietary equities trading and 2) They wanted to revamp their trader training program. They noticed that very few of their new traders could establish consistent profitability in the post-2008 market. That’s where MBC comes in, providing WTG with an NYC branch and an organized trader development program.

In January a deal was made. They weren’t going to call it a merger but instead label it a Joint Venture. WTG would assume a majority stake in MBC Securities and provide a bigger bankroll–more drawdown and more buying power. WTG would also fully back traders without requiring an education fee so the MBC Trading Desk would get a prestige bump in reputation. MBC would provide the training program for both the Austin and NYC branches but still retain MBC Education as a seperate commercial entity.

A date was set to move to a new office in Midtown and officially kick off the WTG-MBC Joint Venture: March 21st. Preparations were made. Tuco was given access to their demo software and he, in turn, gave us access so we could quickly acclimate ourselves to their proprietary in-house trading platform, Pr0Trade. Within 30 minutes of using Pr0Trade, I could see how much more sophisticated it was than the average retail platform. They wanted their platform to be dynamic and tailor fit for any trader’s unique specifications. It had similiar features to our own platform, like order tabs and speed function keys, that were built more for scalping and momentum. It had specialty entry orders and “flip stops” for imbalance trading. They had something called TIX windows where data would feed in on command–could be news alerts, trade info, pnl info, communication from one of their quants/pit guys, or status of stock locates. You could link the platform to the proprietary scanning/scripting program called Pr0Script, which was another massive piece of software in itself, similar to Trade Ideas. It’s just way better than retail bullshit platforms, you’ll have to trust me on that.

Word started to spread around the desk about the deal and we all felt hopeful that a new change of scenary would lead to a breakthrough. For many us, the grind was starting to become too much stress for too little reward. You don’t get into trading to make $40k a year and then struggle to pay your bills. It’s an upside business. The only downside of the new Joint Venture was that our profit splits would get cut from 70-80% range to the 50-60% range but maybe that would give us the kick in the ass to trade more size. A smaller cut of a much bigger pie can still having you eating more.

WTG had a roster full of killers who made 7-figure profits and some of them would fly to NYC to teach us their strategies and maybe just as important, their mindset on taking risk in the markets. Before the Joint-Venture kicked off, Tuco, Mesut, and I met one of WTG’s most experienced top traders since 2002, a man named Riggs, out at a rooftop bar in Turtle Bay. He was taking a short trip from Austin to NYC to let us MBC guys pick his brain and have a detailed look into WTG’s trading history. It was VERY different and here are some of the bits and pieces I can recall:

• In his early days, Riggs was a tape scalper just like us. One of his best strategies was manipulating the NYSE specialist on BRK.A–Berkshire’s A-shares that traded in the 5-figure range with tiny volume. There was a way to pinch the specialist into filling orders in a specific and predictable sequence by only trading odd lots (for BRK.A the round lot was 10 shares instead of 100, so an odd-lot was 9 or fewer shares) and he continously exploited it. This was eliminated when NYSE went hybrid.
• WTG had a super casual work culture; they made MBC look like Morgan Stanley IB in comparison. Traders would wear shorts and flip-flops and play Counterstrike when the market got boring. Riggs joked that a trader could show up naked and avoid reprimand as long as he made serious money. Mr. West supposedly wanted to ban computer games and move the firm more towards MBC’s professional culture of “college graduate try-hards”.
• Almost an entire decade before the Knight Capital debacle, something similar had occurred on a stock called COCO (Corinthian Colleges, a for-profit university company). There was a “smart selloff” triggered and repeated on an endless loop, crashing the stock without any news. Although some trades at the most extreme prices were cancelled, WTG traders were “in-the-know” and able to take advantage.

• He knew a lot of traders who followed an archetype of what Victor was now coining “The Bionic Trader”. To be a bionic trader simply meant using technology and quant tools to enhance one’s discretionary trading. WTG had traders who would create Pr0Script models to find price spikes and fade them–and no, I’m not talking about micro-cap pumps, but super random obscure equities like warrants, convertibles, preferred, and B/C/D-series shares that would average 1k daily volume and spike on 20k volume with zero news. These issues usually wouldn’t deviate too far from fair value (based on the main stock with higher volume) and these spikes were most likely explained by fat fingers or machine errors and would thus correct quickly.

• In the current period, WTG’s best profit centers were all focused on the opening and closing imbalances. If you’re unfamiliar with what an imbalance is, it’s basically the amount of shares to buy or sell that must be matched by the bell to determine the opening and closing price. More on the subject here. Simple run through example: If traders sensed that a closing buy imbalance would lead to an unusually high closing print, they would buy at market in the last 5 minutes of the day and place an order to sell the market close (picture below). It’s super simple and very lucrative. WTG’s best PnL days were often on index rebalancing days, options expiration dates, and new additions to the S&P 500. They dedicated a lot of manpower and support to make Pr0Trade an imbalance-trading machine. Back then, imbalance trading was an obscure strategy that retail traders never took on because it required the pre-existing knowledge, the technology and data, and access to 10-20x buying power. MBC didn’t have a single note in their training program about imbalances, even from an observational standpoint.

• Riggs stated that the 2010 Flash Crash was one of WTG’s greatest days as a firm but also one of their most vulnerable. The size and peak drawdown they took on that day was close to the point of a firm-wide margin call that could have sent them out of business. Traders didn’t care, they just kept buying into the dip because they “knew” it was a once-in-a-generation glitch event. The trading desk’s loose and flippant attitude about risk management was best summed up by when Riggs said “It’s not our money!” Oh, well that’s a novel way of thinking about it. This “hero-buying the market crash” story really resonated with me because it crystalized this theme behind some of WTG’s most massively profitable days: sometimes the market is just 100% wrong and you have to bet on exactly that. It goes against-the-grain to the prevailing cliches in the trading education industry about always following rules, always cutting losses quickly, never trying to catch falling knives and the market always being irrational longer than you are solvent. Maybe over-internalizing all that stuff just makes you a huge nit who can’t hit the button when it’s time to make the trade of your life. You just have know when to break all the rules.

I wasn’t there but this is how I pictured it in my mind:

That’s the alluring proposition of prop trading in a nutshell. You either make a killing or it’s someone else who goes broke.

While they did have traders with straight-forward directional strategies, it seemed like WTG’s elite traders were most focused on glitches and market inefficiencies with an extremely high win rate. There’s this higher level of confidence they have in knowing the market is mispriced and will correct very quickly. Imbalances took time to learn and weren’t automatic wins but they were far less psychologically demanding to trade. You just sit in a position for 5-10 minutes and know right away where you’re at once 4pm strikes. Compare that to us MBC traders getting long at a “key level” on a held bid and we’re sitting on pin pricks waiting for the algo to shake us out and then it might still rip higher anyway. There’s so much pent up anguish over shakeouts and stopouts for hours on end and then on the other hand, you got these cowboys out in Texas making a million flat in 5 minutes. It was almost unfair. They had lived in a different trading universe and spoke an entirely different language. But now we were part of it.

March 21st finally comes around and it’s the first day at our new Midtown office. It’s brighter, more modern, more vibrant. We’re free from the dredges of the Y5 trading floor. Traders are mostly setting up and getting comfortable rather than taking risk. We’re talking to our new support staff and our quants. We’re chatting up the new ringers that MBC had hired–veteran traders with diverse backgrounds in Global Macro, Asian markets, bulge brackets, etc. We finally have traders in quads 1, 2, and 4. A new day has come and everything feels so much more promising again. Management came through and delivered a proper trading environment. Now you couldn’t hide behind any excuses if you failed.

While I’m setting up my Pr0Trade hotkeys and display settings, I have my retail platform up and I’m watching this OTC penny stock with unusual volatility.

It’s a delisted NYSE stock called FNMA.

^{(to be continued in Full Transparency)}