Trading (Part 1)

Part 1: The secret of institutions are generally profitable

This series will express my understanding about trading & different ways to make money. Trading is a zero-sum game (PvP) in its nature. Part 1 will talk about the fundamental of trading profitably.

I have been working in institutions in crypto quant & trading roles for around 2 years, from buy-side hedge fund to crypto-exchanges (sell side).

Retail traders without any professional trading experience would always think institutions are having secret source to make money, but in fact, most of the time, they are trading profitably in general because they take risk premium & manage it responsibility. And for those top 1% profitable, they usually have a sort of secret alpha that others cannot replicate it easily.

Here is a typical example, for crypto structured product desk at exchanges, the principle of making money is the trading team prices the product at around the ‘fair value’ from all those math models, and then they mark a spread (i.e. a premium) on top of the product, that is supposedly sufficient to compensate the hedging cost of writing the product. The main factor that drives the profit in this case is actually not quite relevant to the trader itself, but more related to the exchange the trader is working at. Given if the exchange has more assets deposited & better reputation, it can reach a bigger notional as to sell the product at a a premium. The alpha is the exchange itself regarding the access of capital.

The other example is market neutral funds and market making firms, their profit steams from managing their inventory across different exchanges. The working principle is the almost the same, that is taking risk premium to manage margin & hedge the delta exposure & time in market.

Most of the institutions tend to profit from risk premium as their bread & butter because they know it is hard to make profit steadily & consistently from profiting from delta in a long run.

For retail traders, it requires you to have a predictive model to make money. As trading is a zero-sum game, one of the easiest way too increase profitability is selecting the right market (asset class), where there are more people make irrational decisions than you do, you can survive and out-perform the market.

The next part will talk about the source of alpha for different trading approaches.