Hot Topics in Proprietary Trading – with Steve Spencer from SMB Capital

Last year I interviewed SMB co-founder Mike Bellafiore. Now I had the chance to speak with his partner Steve Spencer about some of the hot topics affecting proprietary traders in the current market environment.

Steve shares a lot of great insights for anyone looking to improve their trading skills:

Damien: Good afternoon, everybody, and welcome to the Wall Street Cheat Sheet Podcast. Today, I am speaking with the co-founder of SMB Capital, which is one of my favorite prop shops on the street.

SMB specializes in proprietary trading. They run a floor on the street with a bunch of traders, and also, one of their biggest missions is to make trading education better for prospective traders. And I, obviously, think that that’s a great idea, given how many people try their hand at trading every year and fail. These guys at SMB Capital are doing an excellent job teaching people how to trade professionally.

And today, co-founder, Steven Spencer, is with me. Steven, welcome to the show.

Steven Spencer: Hi, Damien, thanks for the kind words. I’m happy to be here today.

Damien: Great. Well, Steven, one of the hottest topics right now is, obviously, the financial reform, and I was just wondering, how does – most people think of how financial reform will affect the big banks—the investment banks, even community banks, and the investment business from sort of buy and sell side standpoint for brokers. How exactly will the financial reform bill, or at least what we know of it so far, affect proprietary trading shops such as SMB Capital?

Steven: Sure. The respective financial reform (inaudible) we didn’t see what exactly comes out of the bill over the next couple of weeks and see if it gets passed. But, the first thing that comes to mind is we’ve been contacted probably, by more traders from some of the larger banks (inaudible) who are concerned about their divisions being eliminated. And we’ve also had more applicants to our firm because many people who traditionally apply for those jobs have been discouraged to do so. So, in that sense, in terms of – from a personnel standpoint, I think we’re already seeing some impact there.

In terms of other impacts on us, I guess, it really will depend on, will it bring greater transparency to the marketplace? Will certain things, in terms of trading that were allowed before, that were allowed behind closed doors, will they no longer be allowed? And will more information be readily available to people such as us who don’t really have connections to have this type of information? So it makes a more of a level playing field from a trading standpoint for us, but, again, hard to really comment on it until we see exactly each and every provision that’s going to be in there. But so far, that’s what I feel.

Damien: Do you sense that eventually a lot of these derivatives are going to be brought into a public market and that will somehow affect – or not somehow, but will definitely affect the – another level of information that your traders will have access to?

Steven: Yeah. I mean, I think that’s a great thing. Any time that we can have more access to different products, and what people’s level of interest is in those products, it makes it a more level playing field for trading equities which we focus on.

And so, for example, there’s a transparency in the option world. We know if somebody’s making a large trade in the options world, putting a big call position on or put a big position in one of the equities we’re trading and we can tuck that in, into our decision making.

If people are making huge bets in the derivative markets on the success or failure of particular entities, and we have no access to that information, then I – and I believe I see that as a handicap, and so, I’m all for those things having more transparency and not being a complete free-for-all from a trading standpoint.

And then also, if I take my hat off as partner of a trading firm, just as a person who is a part of this country and part of, you know, “I want a stable economy, and I want things to work and for us to grow and do well.” I do not want these trillions of dollars of things done behind the scenes and there’s no transparency where I can just topple and bring down our entire financial system.

So, from that standpoint, I think it’s important as well.

Damien: And that’s a great point about bringing down the system. We – the last time I spoke with Mike, and we did a little interview, it was not too long after – where it was right around the big – the time of the big crash. And I know that we discussed the sentiment on the trading floor during that time, but since March, we’ve obviously had an incredible snapback rally that very few people predicted.

I was wondering, how has – how have things changed now that volatility has at least relatively come down since then and the markets have rallied? What’s the feeling on the trading desk and the emotions in your environment?

Steven: Sure. I think that anytime you go from a once-in-a-generation type trading environment, which we had in 2008 where the (VECs), you know, was up in the ’70s or ’80s and traditionally, has been in the 15 to 20-area, it created an incredible amount of opportunity.

So, we had new traders, we had new business making $5,000, $10,000 a day, putting up these ridiculous numbers and people got very spoiled by that level of volatility. And many people who thought that they were professional traders, when they really weren’t. They were trainees. They were people who were new and they were spoiled by this – the ability, basically, to put trades on that we taught them and instead of being rewarded by a 20- or 30-or 50-(inaudible) moves, they were rewarded with 5-, 10-, 15-point moves.

And when we had that transition where the market started to calm down last March and we started to trend up very slowly. Well, it was very difficult for those without years of experience to go from an environment where there were short – or long, there were short and just trading the volatility to, “Okay, we need to start to think about taking positions in riding some of these slower moves.” And that was a rough transition for a lot of people and I think that, you know, in the prop trading world over the last year, a lot of people have been shaken out.

I think in the last six months or so, I think people have, really, on our desk, especially have started to see that with this slower volatility, a couple of things are really important.

Number one, if you find a good short-term trade, whether it’s an (inaudible) trade or a multi-day trade, once you find a good entry, you really need to milk that trade for everything it’s worth. And the people in our desk have done a good job of transitioning to that.

And then the second thing, which are the style that we are –we’re big proponents of, one of the things that’s at our core, which I believe most firms don’t focus on, is we’re looking for where the volatility is on a daily basis.

And so, we’re not trading the market per se. I’m not trading, you know, the (SMB) or the (cues) on a daily basis, those may not move that much anymore. They have very small moves, but if I’m in at Akamai, in AKAM today, or I’m in (R-I-G or RIG), when there’s fresh news in those stocks, it’s like 2008 to those stocks. They don’t care that the volatility overall has come down in the market. There’s fresh news and the momentum players have to be in those names, and they’ll push them up and they’ll push them down. So, for us, as long as we can find two or three of those names a day, it kind of creates that sense of 2008 for us.

Damien: So, do you see sort of a little bit of a waning in the amount of people that are taking up interests in day trading or proprietary trading now that we’re sort of moved away from a space where, you know, people are telling stories to their friends that, you know, they shorted AIG for 20 bucks, and there’s a – you know, they shorted a layman to a broker. Because these stories aren’t out there, is that changing the amount of – the number of people, quantity of people you’re seeing?

Steven: Well, there are certainly the stories that I got hit in a bid at 600 (inaudible) yesterday and I just kicked it out of 720 today. So, that’s – they still have their stories.

I think that we still receive a ton of resumés every week. You know, I’d have to go consult with the HR person to see what the exact numbers are and see if there’s been a drop off over the last year or so. But as far as I know, they still have me interviewing two or three days a week and there still seems to be demand. And the other thing is, yes, there’s not that level of craziness where people are (catching) 20- and 30-point moves everyday, but when you have a very strong market and the market is rising steadily, there’s certainly opportunity on a daily basis. And so, I think that attracts another set of people as well.

But I would really have to get back and check with the HR people and see what exactly the numbers are.

Damien: How about – also, you guys run a public blog, the, which is an excellent resource for traders. What about in so far as the home-gamers are concerned, is there any change now with home-gamers being a little more frustrated or not having as easy access to volatility?

Steven: You know, the ones who follow our blog closely, definitely understand that we seek out the volatility on a daily basis. So, I think a lot of the comments we get from them, in terms of frustration, is more on the, “Oh, I got with that at some position because the (HR keys) pushed it through my (stop).” But the people, who generally are commenting and in touch with us, who follow us through our blog, seem to be, for the most part, for my standpoint, in the right stocks. Now, if you’re in the right stocks, that’s 90% of the battle.

Damien: And speaking of where the markets are and the right stocks, Steven, what type of stocks have been pretty full of momentum in general lately since – I know there’s a lot of people who keep setting up in shorts and at least through the mainstream media. You see a lot of people get – sort of suckered into preparing for the next big drop and the next big drop and I’ve seen that over the course of since basically last March, everybody’s been looking for the next big crash, but the market is going on in a different direction. What sort of stocks and plays have actually worked out well for your group?

Steven: Sure. I think one of the plays that’s working really well are stocks that over the past few months have touched 52 (inaudible) two, three, four times. And then, within – recently, let’s say, the last four or five days, we’ll consolidate clues to that level within a point or two. When they’ve been taking out that level, they’ve been having multi-point breakouts.

Now, the majority of the time that trade has been working. We did notice since the Goldman Sachs fraud charges came out, I think the percentage of that trade working has dropped off a little bit. And usually when a particular pattern is working really well, generally, people are able to gain that pattern a little bit more and it starts a lower percentage at the time.

One of my favorite trades in a strong market is always the stock that gaps up, has a strong opening drive, consolidates well above the opening price and takes out the morning high. Generally, there’s follow-through and if you will look at the chart in AKAM today, you’ll see that that’d be staying around 38.

When it took out the morning highs above 39, it actually went up another point or so, I believe. And, you know – but it’s also – and also, AKAM has other things going for (inaudible). It’s in the content delivery space and the broadband space and in the mobile, the expansion of the mobile Web and everyone with the Droid phones and the iPhones, they’re right in that hot (bed of) activity. So, I think the momentum (inaudible) and that the growth managers probably had to buy that up today in that (play) department. So, I don’t think it was just simply a technical play, but I think there are also some fundamental reasons why that particular trade worked out.

Damien: So, Steven, what are some of the plans that you and (Mike) have for SMB Capital in the coming month? You know, we’re going to be getting to the summer time and that’s usually a pretty fun time in Manhattan. Everybody comes out of their winter shelf in a major way, and it seems to spark lots of creative ideas and new directions with businesses. What do you guys have planned for the rest of this year?

Steven: Sure. Well, coming up in June, actually, we are having a six-month training program, where we’re bringing in a bunch of people and going to train them for six months and those who perform well will be offered an invitation to trade for our hedge funds, under our hedge funds. And so, that’s the primary thing that we will be focusing on this summer. For myself, personally, I think come August, I’ll try to take two or three weeks off. I say that every year, and usually, it doesn’t materialize, but that will be one of my focuses.

And then the other thing, beyond the fact that we’ll be very busy with a whole bunch of new trainees, and, probably, a bunch of interns, is you mentioned this early at the beginning, which is we’re trying to make our training accessible to those who were invited to be a part of the firm and work to those around the country and also in other countries throughout the world.

And I’ll probably be working with director of our remote training program to continue to provide more offerings to people who are interested in learning how to become pro-traders and try to provide them 100% the experience that they would have if they were someone who were actually invited to train with us on our desk in New York City. And that’s quite an undertaking. And so, my schedule will probably be full there.

I’m sorry for not talking about Broadway shows and, you know, I guess, I’ll try to go to Shakespeare (inaudible) up there to pick up tickets for me one day during the summer to catch one of those shows. Maybe a little Bryant Park Monday night at the movies as well and just enjoy, you know, what Manhattan has to offer during the summer.

Damien: Well, that sounds quite familiar. (Derrick) and I are trying to grow, obviously, just one business being a media business and you are trying to grow both the trading desk and education arm of your firm. So it seems as though you, definitely, will be a busy guy.

So, Steven, I wanted to thank you very much for taking the time to chat with me today. And I was hoping that you and I could again touch base maybe at the end of the summer and see how things are going over at SMB.

Steven: That would be great, Damien. I appreciated chatting with you today and thanks for your time as well.

Damien: Thank you, Steven.

So, once again, everybody, I would like to thank Steven Spencer, co-founder of SMB Capital. You can find SMB Capital on the web at and they also have an excellent blog which I recommend joining their RSS feed for some great daily insights and get you started with trading. If you’re more intermediate or advanced trader, they have some excellent products, which I’ve personally tested myself, and they’re very valuable. And also, lastly, you can follow SMB’s Twitter.

Steven, what’s your Twitter handle?

Steven: @smbcapital.

Damien: @smbcapital. And they always give everybody their, you know, trade-of-the-day or something like that and it’s a really nice way to get an idea of what stocks are in play for the day and start introducing yourself to the group over there.

And again, thanks to Steven and we’ll see you next time on the Wall Street Cheat Sheet Podcast.

Steven: Thanks.