Trading up...

Hannah Langworth takes you through this popular area of finance – it's not just banks who get involved

Trading is one of the most well-known parts of the finance industry - most people have seen pictures of the hustle and bustle of the trading floor, and it's easy to appreciate how investment banks and other participants can make money through quickfire buying and selling. Trading is also one of the most notorious areas of finance, thanks to the role trading activities played in the financial crisis, and because of the rogue trader scandals that periodically hit the headlines.

There's a lot more to trading than getting it cheaply and passing it on for more, and trading activities take place in many more locations than the trading floors of investment banks. Here we give you the details, so that you have a full picture of this fascinating area of finance work.

What trading's all about

As you'd expect, trading in the finance world is essentially about buying and selling. A huge variety of different assets are traded every day on the financial markets.

The main types of assets traded are:

  • shares: slices of ownership rights in a company, also known as equities, or stock
  • bonds: pieces of corporate debt
  • currency: for example, dollars, yen, or euros
  • commodities: physical goods such as oil, copper, silver, or cocoa.

As well as trading in assets, another important aspect of trading is the sale and purchase of derivative products. These are contracts granting rights over (or, derived from, hence their name) underlying assets, such as the ones listed above, and they have a financial value in themselves.

The main types of derivatives traded are:

  • swaps: contracts under which one party agrees with another that they will "swap" one asset, usually a cashflow, for another
  • forwards: contracts under which parties agree to buy or sell a particular asset for a particular price at a particular point in the future; forwards traded over an exchange are known as "futures"
  • options: contracts which give a party the option to sell (a "put" option) or to buy (a "call" option) a particular asset at a particular time and price.

Why trading takes place

There are three main reasons why parties engage in trading activity.

  • To obtain an asset that they need: For example, a chocolate company will need to buy cocoa and sugar from producers of these commodities, while a manufacturing company might need certain amounts of a particular currency to pay suppliers located in a country where that currency is used.
  • To manage risk: For example, an oil company might purchase options to ensure that, however oil prices fluctuate, it's guaranteed a good price for the products it produces.
  • To make money: For example, an asset management company might invest in shares that they think are going to rise in value over time, or a currency trader at a bank might take advantage of fluctuations in exchange rates to generate a profit for their bank.

Trading at investment banks

Investment banks are major players in the trading arena. The trading activities they undertake could be either for clients, or for the bank itself (known as proprietary trading).

To take trading conducted to assist clients first, there are two main types of trading services that investment banks provide. They may buy or sell assets on behalf of clients, for example, to enable a manufacturing client to obtain a quantity of a particular commodity that they need, or to help an investor gain exposure to a particular financial product or market.

Alternatively, they may offer derivative products to their clients. For example, a client required to pay a floating rate of interest on a loan they have taken out may wish to switch to paying a fixed rate of interest. An investment bank might offer to enter into a swap agreement with that client, meaning that the client pays a fixed rate of interest to the swap providing bank while that bank (for a fee) undertakes to pay the floating rate interest repayments required by the lender.

To move on to proprietary trading, these activities may be undertaken by an investment bank purely to make a profit. For example, a trader may invest in a particular commodity if they think demand for it, and hence its value, is likely to rise in the future.

Proprietary trading activities may also be undertaken to protect the bank against the risks it faces. For example, when the bank enters into derivative products with its clients, it may then wish to undertake other trades in order to protect itself, known as hedging. For example, if it agrees under a futures contract to provide a particular quantity of a particular currency to a client on a particular date, it may choose to enter into another futures contract itself in order to guarantee its own supply of that currency on that date. The bank will obviously ensure that the costs of entering into this futures contract do not outweigh the profit it will make from the original futures contract entered into with the client.

Trading outside investment banks

Investment banks are not the only graduate recruiters that employ traders. It's also possible to work as a trader at a number of other institutions.

Proprietary trading houses

Proprietary trading houses are firms which seek to generate a profit purely through proprietary trading. Often these firms organise themselves as syndicates of self-employed traders. Recruits receive the benefit of training, execution services, and facilities from their firm, but do not receive a salary, instead splitting their own trading profits with their employer in a pre-agreed ratio.

Proprietary trading firms which recruit and trade graduates include Futex and Schneider Trading Associates.

Commodity trading firms

Commodity trading firms are essentially proprietary trading houses which specialise in trading in commodities.

Firms participating in commodity trading which have graduate schemes include RWE Supply & Trading and Glencore.

Energy companies

Energy companies are major participants in the energy trading markets.

An oil and gas company will trade in the financial markets in a number of different ways.

  • Sale of their products: They will use the financial markets to sell their products to customers.

  • Purchase of commodities from other producers: On some occasions, it may be necessary for an energy company to obtain products from other producers to satisfy the needs of its customers. It will do so through trading on the financial markets.
  • Risk management: An energy company may use derivative products obtained through the financial markets to protect themselves against the potential financial risks to them of fluctuations in oil and gas prices, or of delays or disruptions to production. Global energy company BP has one of the most well-established energy trading graduate programmes.