Transcription
Hey, what's up guys? So I want to go over three ways to steal millions of dollars from a trading firm. The context here isn't that I condone doing this. So, the first two ways people do this are illegal, and the third way is not illegal.
The first two ways are actually one of the reasons why trading firms tend to hire these cohorts straight out of academia rather than hire experienced traders from competing trading firms. So, the first way you can steal millions of dollars from a trading firm is by trading with yourself. Let's say you're trading options on GameStop. In all the chaos of all the trading volume happening throughout the day, it's easy for people to just pull out their phone and open up Robinhood or something and leave a resting order to buy GameStop way lower than where it's trading. Then they can just look up at their trade desk and sell it to themselves.
People do things like this, and so trading firms want to prevent that. So, the compliance department comes up with a list of asset classes that you're simply not allowed to trade if you're an employee of a firm. Not only will they ban you from trading those things, but they demand to have a live feed of your activity with your IBOA. So, if it's like your last day at the firm, like you're mad about your bonus and you plan on rage quitting, you might like run to the bathroom and like go sit in one of the stalls and then put out all these resting orders on options on GameStop, like far away from the mid-market so that other people don't trade them with you. Like, let's say something's trading at 100 and you put out all these resting orders, these bids at like $95, and then you run over to your trade desk and you just sell. You hit those bids because you know that that's just you on the other side, and then you get filled on your phone. It's basically a way of siphoning money out of the firm into your own pockets, and then you just quit that day.
Firms know that people do this and they're concerned that people will do this in a really big way. So, they demand a live feed, and if they see any activity of you trading anything related to the list of products that you're not allowed to trade, when you leave the bathroom to come back to your trade desk, the security guard will tackle you like an NFL linebacker. So, there's this real-time aspect to the money that can be made or lost. And so, they do things like this, you know, you don't get a box where you get to neatly stack up your things and put it in the box and then get like escorted out of the office. Like, they just straight up push you physically out of the building, and then they'll mail you your belongings later at the address that you give them. And I've known people who've done this, been abruptly fired, and I'm sure there's tons of people who've done this and not been caught, and it happens all the time. But that's why the compliance department in these firms are so big now.
There's one layer of this that's more complicated. You have to be pretty naive to think you can get away with trading with yourself like that at most firms. So, people will obfuscate it by one extra layer where they'll get their brother-in-law or someone that they're close to to put the resting order out there for them. So, they'll just say, "Hey man, I'm like Tuesday at 10:00 AM, put out a resting order on a back month option on gold." Put these, and all this jargon is just to say it's like an illiquid part of the market. So, it'll be obvious that that's your brother-in-law who's putting the resting order out there. And so then at 10:00 AM on Tuesday, you'll go check out that part of the market and then you'll see your brother-in-law's resting orders, and then you'll give up edge to trade with him. And you can just do that once or twice a week and blend it in with all of your other trades. So, compliance departments might not see it. And even if they do see it, traders give away edge for different reasons. Sometimes it's to reduce risk. You know, if they're getting piled into a position that's risky, they can give up edge. Sometimes to reduce risk, and there's other reasons they might be speculating for one reason or another. And you can kind of cover your tracks pretty easily too. Like, most prop trading firms have a valuation system that tells you if a trade has edge in it, and you can manually override it with quote-unquote trader intuition and change the parameters such that the trade looks better. So that'll kind of hide it from the compliance department's watchful eyes. And so, yeah, you can manually change, manually override the parameters, trade with your brother-in-law, and then revert the trading parameters back to what they were before, and no one will notice. And you can do that two or three times a week and make like a few thousand dollars each time. And, yeah, I have no doubt people have done this and do do this, and I know people have gotten caught trying to do things like this. And to even get out of the trade, you don't have to trade the same thing, the same strike with them. You can trade one strike over. You're letting your brother-in-law leg into like a skinny put spread or something that can't lose money. But there's different ways to do this, right? And then in case there's like people tracking you, it would be kind of dumb if your brother-in-law vows you money, like half the cut or something. He'll probably just eventually buy a vacation home or something and let you go there whenever you want to, you know, something like that that's harder to track. Yeah, people get away with doing stuff like this. So, if you ever start a trading firm, this is something to look out for. Trust is a really big part of the industry. It's really easy to steal money from a trading firm if the people who work for you don't like you anymore. And that's why a lot of owners and partners of trading firms are very abrupt to fire people because of concerns over things like this.
The second way to steal millions of dollars from a trading firm is to work for a competing trading firm where you trade the same desk, and then you move over to the new trading firm and you stay in touch with the traders of your old trading firm, and you're basically a mole, like a spy at the new trading firm that's giving information to your old trading firm. And again, this is why loyalty is so important in the trading industry because it's really hard to track when someone's doing something like this. You know, you don't even have to text them information, you can just meet them for happy hour. Most of these firms are in the same cities like Chicago and New York City, so you can just meet your old colleagues at happy hour or just go to their house and be like, "Alright, these are the positions we have on right now. Next week's FOMC number, we're planning to do this. If it goes up, we're going to do this. If it goes down, we're going to do this." And they have all this information, and you don't have to know how they're going to use that information, but they can make a lot of money off of your firm by knowing all these details about what you're doing. And so your new firm will slowly just be underperforming a little bit, and to them, it'll feel like the market just knows what they're going to do. You know, like a poker player that can see one of your whole cards, and they won't quite know why, but their strategies just won't be as effective as they were before. And so, let's say they lose two or three million dollars a year while you're there being a mole, not altogether, just they make two or three million less than they would make. Let's say they make 10 million a year on average, they might make seven million. And that extra two or three million is going to your old trading firm, your old trading desk. And then two or three years later, you go back to your old trading firm, and because you have this understanding with the head of the trade desk, you'll get rewarded in some big way where, you know, you get some contract or you get some title there that's like way higher, and you get paid a lot more. And so people do this, and that's why again, loyalty is so important in the trading industry. It's not too dissimilar from, you know, being president of the United States. A lot of presidents go into the presidency worth like $2 million, and then they basically look the other way or pass certain regulations that favor like one particular firm or industry, and then once they leave the presidency, they get a consulting gig where they get paid like $100 million over five years. Coincidentally, it's those same firms that they look the other way for. And so there's a bit of this scratch my back, I'll scratch her back kind of thing. But the way people are doing this in trading firms is obviously it's like impossible to track, you know, how would you track that? So again, this is why trading firms hire naive kids straight out of college, smart kids straight out of college that have no industry connections because they're concerned about having spies and moles in their trading firms that are basically sabotaging their strategy, and they'll have no way of knowing. The only cases where they don't mind you having industry connections is typically if it's like your dad is the CEO of like the Chicago Mercantile Exchange, or you know, your uncle is high up at like a well-known data vendor or at Bloomberg or something, because those are businesses that are adjacent to the trading firm, and so those contacts could come in handy, but they're not direct competitors to the trading firm. And so you see people with those kind of connections get pulled into trading firms really quickly for that reason. But again, yeah, if you're if your dad is the CEO of a competing trading firm, like they're not going to say this to you because it probably violates some kind of hiring laws, but it's definitely going to hurt your application, it's not going to help it, believe it or not, and for the reasons I just outlined.
The last way that people steal millions of dollars from trading firms is legal. It's by learning a strategy, then learning the entire tech stack around the trade desk, and then taking that strategy and leaving the firm and trying to reconstruct the strategy on your own. So, people do this all the time. It can look a couple of different ways. One way to do it is just to do it from scratch, from the ground up. So, you basically try to rebuild the whole strategy in your own trading firm as like an LLC. So, there's a lot of two-person and three-person trading firms that exist. They're sprinkled all over downtown Chicago. If you look at the listing of companies at the Board of Trade building, for example, like every floor will have these small trading firms that are like two or three people or five people. And they just trade one strategy. It's basically one trade desk, but it's an entire business built out of the trade desk. And almost all these people are former traders from the big tier one or tier two trading firms that just thought, "Alright, I'm not going to get to move up much higher at this firm. The best move for me is to just try to reconstruct this trading strategy out on my own." And so you get a ton of people like that. And some of them fail because they underestimated the complexity of the tech stack, but others of them, they succeed, and they just kind of quietly make $2 or $3 million a year at their small little trading firm. And some of them make more. They'll make $5 to $10 million a year just quietly split up between two or three people. And some of these little spin-off firms grow and then start to compete with the parent company that they spun off from. It happens all the time. I think Akuna is a spin-off to Oper, and Headlands is a spin-off to Citadel. And the entire Chicago trading ecosystem is just big firms with a bunch of small spin-offs from them. And those some of those spin-offs grow, and others of them fail. That's pretty much what the entire ecosystem looks like now.
People don't always just start their own LLCs. Others, they'll leave a trade desk at an established firm to try to start that trade desk at a competing firm. And while most trading firms trade the same products, you know, they have a bonds desk, crude oil desk, whatever, VIX desk, here and there are trade desks that only exist at one firm. They don't exist at a competing firm or a growing firm that doesn't have that desk yet. So, if the timing works out for both parties, you can kind of talk to a competing trading firm and say, "Hey, I'll bring over this VIX desk. I noticed you guys don't have one. It'll complement your S&P desk well." So, you can start that trade desk at the competing trading firm, negotiate a way better contract, a way better cut of the P&L than you were getting at your old trading firm. And so that's something a lot of people will do. It's a bit easier than building out all of the existing tech infrastructure from the ground up. That's a big hurdle in and of itself. And then, like a medium porridge between both of those options is joining somewhat of a trading arcade. So, there are firms where the firm sets up the core tech infrastructure for you, like high-speed trade connectivity with the exchange and things like that, access to Bloomberg terminals, but it's just the barebones tech infrastructure. And then you bring over your trade desk. You might bring over one or two of the traders from your trade desk, and you try to reconstruct your trade desk at this trading arcade. The contract there will typically be even better than with the competing trading firm because you still have to do a lot more of the heavy lifting yourself. There's a bigger chance that you'll fail. People go that route a lot too. So, there's basically just kind of like different layers of how much of the system you want to rebuild from the ground up. Those are three different layers I'm familiar with: going to a competing trading firm and starting your desk there, going to a trading arcade, and then building the entire company yourself from the ground up through an LLC. And people succeed and fail at all three of them, but they all chose to take that risk because they just thought they would have more success than trying to climb the ranks within their old, pre-existing trading firm. You know, a lot of these big established trading firms are very political, and moving up in them is a fool's errand, and you often hit a ceiling, and you're not going to be able to move up much higher than that ceiling. So, yeah, those are those are the three different ways that people try to steal millions of dollars from a trading firm.
And okay, and you're probably wondering about non-competes. Like, well, what about non-competes, dude? Yeah, I mean, these established firms, they have non-competes, but they're usually six months to a year long. And a lot of these strategies, like options market making, for example, they have a deep moat. So, they've been around for like 20-plus years on the screens, and they still make money. Now, every firm has its own unique flavors of how they run these kind of strategies, but they all still make money. The trading ecosystem extracts billions of dollars out of the exchanges in Chicago every year, so there's still money in it. So, even if you have to sit out for a year, the strategy will still have money in it a year later. So, people still do this. During that one year, you can still start building out the tech infrastructure and do things that aren't actively trading, and it wouldn't violate a non-compete. And the rules around non-competes are constantly changing. There's some recent legislation that passed in Illinois that basically said non-competes are completely unenforceable, and every lawyer I talk to has varying opinions on the validity of all these changes, so it's hard to say. But the point being, even if you fully honor a non-compete, in the full year, or some places have two-year non-competes, but those are kind of rare. I'd say the average non-compete is six months to a year. So, even if you sit out for the whole year, the strategy will still be there a year later. So, it's not that big of a deterrent for a lot of people who have big dreams and want to be the top dog and make a lot of money. They don't want to just grind their way up the hierarchy at a tier one trading firm, and this is the solution that they go with anyways. Yeah, I hope you learned something about the concerns that trading firms have of people stealing millions of dollars from them. Take care.