Brokers, Trading Education

How Do Big Banks Profit Everyday From Trading?

It might seem preposterous that large investment banks are able to make money daily, when day traders consider themselves lucky to be profitable after an entire week. However, big banks hold several advantages compared to individual traders. Their access to scarce data, ability to make more strategic trades, and intelligent employees allow them to collect profits everyday. Furthermore, banks actually do frequently take on losing trades, however, the diversity of their trading strategies ensures that at least some positions will be profitable at any given time. 

Banks Own Unique Data

Big Banks are able to purchase and access scarce data to find unrecognized inefficiencies in the market as they possess enormous amounts of capital and resources. Finding inefficiencies that others cannot increases the chance of profiting. Meanwhile, many day traders do not even have access to common financial information to help them make informed decisions, as a Bloomberg Terminal alone costs $20,000 annually. 

Banks Trade Much More than Individuals

Given that banks on Wall Street have billions of dollars under management and hundreds of employees, they are able to enter and exit as many positions as they wish on a daily basis. The more strategic trades you make in a day the likelier you are to profit as your daily results are more likely to fall in line with your overall expectancy (assuming you are a winning trader). As independent traders only average 5 trades per day, their daily results are not representative of their overall success. Additionally, since banks have many brilliant employees monitoring risk across sectors and asset classes, they are able to safely trade much more over the course of one session than any day trader. 

Banks Employ Some of the World’s Most Intelligent People

Employees who research and trade securities at large banks are among the brightest individuals on the planet, as they are typically former students of the most prestigious universities across the globe. Teams of these brilliant minds use their collective knowledge to form trading ideas, which increases costs but also increases success rates of bank trading desks. 

The Big Picture: Investment Banks Do More Than Trade

Many investment banks service clients by making markets, providing brokerage services, and offering a variety of non-trading services such as wealth management, debt and equity capital markets services, and M&A advisory. Market making and brokerage both involve participation in financial markets, however, these services are designed to facilitate the trading activity of investment bank clients. Wealth management involves designing long-term portfolios for high-net worth individuals and institutional clients; banks provide advice which considers tax implications, estate planning, risk tolerance, and a variety of other factors.

Debt and equity capital markets services connect companies seeking to raise capital with interested buyers. Finally, M&A advisory is offered to private equity firms and corporate clients seeking to merge or acquire other firms. The important point to consider is that all of these services involve an investment bank providing a service for clients in exchange for a fee, rather than placing trades based on their own research. To illustrate this, examine the segment breakdown of Goldman Sachs, one of the largest investment banks in the world, below:

Source: FactSet

Notice that Goldman does not even consider trading its own segment. Global Markets and Investing & Lending both contain revenues from Goldman’s own proprietary trading, however, much of that revenue also comes from servicing clients. Ultimately, although banks employ very talented staff and invest heavily in sophisticated trading models, their consistent ability to generate revenue is largely a function of their diverse business lines rather than an infallible perspective on financial markets. Given this dynamic, retail traders should not benchmark return consistency against the reported revenue/income of investment banks. Instead, traders should use index benchmarks (such as the S&P 500 for equities) for their respective asset classes to evaluate performance. 

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