The World According to Lewis Borsellino
Lewis Borsellino has worked as a market-maker on the floor of the Chicago Mercantile Exchange for more than 18 years. By 1986 he had become the largest single player in the Standard & Poor's 500 pit, regularly accounting for 10 percent of any given day's volume. During this time, he also racked up more fines for fighting and other physical incidents than any other floor member at the Merc. He is the author of The Day Trader: From the Pit to the PC, published by John Wiley & Sons, and is the founder of www.TeachTrade.Com, an educational web site for stock and futures traders. He spoke with editor Joe Kolman in February.
Derivatives Strategy: You're known as the quintessential floor trader. What made you interested in moving off the floor to an electronic medium?
Lewis Borsellino: I began electronic trading for two reasons. First, I'd just turned 40. I'd been on the floor for 19 years. And one thing I believe is that in life you have to do what you are good at. Getting off the floor and trading by computer would be a way of extending my life in this business.
Second, I've always backed floor traders financially. I'd get them started and they'd eventually go on their own. I have a couple of those still, but now all the traders we back are based at computers. I think this gives us greater global capability. Some day you'll sit at a computer screen and be able to access any market in the world. You'll type in the symbol, hit buy or sell, and your market will be available no matter where you are.
DS: What are the major differences between trading on the floor and upstairs?
LB: Upstairs trading is just as emotional as downstairs, except there's no yelling and screaming. You go through the same gut-wrenching process when the market's against you. The thing I had to get used to was a lot more waiting. If I went down to work for three or four hours in the Standard & Poor's 500 pit, in a busy day I'd trade 5,000 lots. Upstairs I'll be trading 20 or 30 lots and looking for bigger moves. I won't trade as much as I would on the floor. But if you look at the downstairs movement, you'll see a lot of "scratches,” a lot of opportunities to get in and out—a lot of little profits and losses.
When you're upstairs, you see those patterns on the chart and you have to be able to look at the computer and act on them—and start developing an "upstairs feel.” You've got to be very precise where you put your orders and how you manage your capital. The game is still buy low, sell high—you just have to be a little more patient. You have to have a plan and execute your trades accordingly. On the floor, you also have to have a plan—but there may be a lot of mini-plans inside that one master strategy.
But you definitely have to be a different sort of trader when you're upstairs. You won't trade as frequently. You're looking for definite entry points, stops and exit points. Every trade has what I call a set-up, trigger and fire. You see the set-up, pull the trigger and then when it's ready, boom! You fire and you go. Down on the floor, that process can sometimes happen in milliseconds.
DS: Can you give an example of a trade on and off the floor?
LB: On the floor, I might buy at 1353 and know I'm going to get out with a "mental stop” if the market drops to 1351. But what sometimes happens is, I buy at 1353, it goes down as low as 1351.50, then it might firm up from there. If I'm on the floor, I can see it firming up. So instead of waiting for it to go down to one, I'll buy at 1351.50, 1351.80, 1352, and bid it back up through 1353, and start scalping in and out on the long side. I'll keep doing that until my upside objective is reached at 1357.
But when you're off the floor, you buy those 1353s, have your stop in at 1351, and are very disciplined about your stop point. Upstairs you have an entry point, a stop point and an exit point. You can't scalp in and out in between trades. You have to have bigger potential on the upside—you have to look for higher probability trades. On the floor you can be a little looser, and flip the cards a little more because you're scalping in and out of the situation.
|Upstairs, you can't see the body language of the order-filler; you can't tell whether he's getting nervous. There are a lot of nuances that go with 500 people standing in a small area trying to make money.
There's a difference between a trader and a scalper. The role of the locals in pit trading is to provide liquidity for people who are looking to access the market—such as institutional customers, in the case of stock options or futures, who are long or short the indices and want to hedge their orders. The local comes there with his own capital and sits in the pit.
The scalper, when he's working on an institutional order, will come in when the market is going out of equilibrium, and make one or two ticks on each trade. He can do that all day long without an opinion. He's just hoping for the market to have some temporary lack of equilibrium, and he provides liquidity for the institutional orders. That's the way the system works.
DS: But you're not a scalper. You're more of a position trader.
LB: Basically I trade with an opinion based on a lot of technical analysis. Even though I'll go in the pit and scalp, I am more of a directional scalper. I go in with a clear opinion on whether I want to go long or short, and I may change that direction based on ongoing research—and according to different market levels.
After 19 years, people say you trade by gut. But I think there is sometimes a fine line between gut reaction and analysis. I use in-house technical analysis and two or three outside resources to try to do some consensus building. Even though I may be responding to the analysis we've done, I'm also acting on my experience. After all, technical analysis is the study of patterns, of history; and after 19 years a lot of these things have been internalized.
DS: So upstairs you can't really be a scalper?
LB: No, because you don't have the line of sight. You can't see the other brokers, whether they're short or long. You can't see the body language of the order-filler; you can't tell whether he's getting nervous. Maybe he'll have 200 or 300 to buy; he hits the area where he has to buy it and he gets into a frenzy. There are a lot of little nuances that go with 500 people standing in a small area trying to make money. To the average eye it looks like total chaos, but it's really the most organized disorganized business in the world. And where else can you have millions of dollars trade hands every day on a nod and your word...and without a lawyer?
DS: Do the people you hire upstairs require different skills?
LB: No, we look for someone that we can train to be extremely disciplined. If you can't be disciplined, you can't be a trader. I get a lot of resumes from people who say they are professional gamblers in Las Vegas. It's funny that they equate gambling with trading. I believe they're nothing alike. This is a decision-making process—we're making very educated, very disciplined percentage plays. In gambling you have no control once you throw those dice. Here we have control over when we get in, when we get out and how we manage our capital.
DS: A lot of locals are worried about their future. What do you tell them?
LB: If you're trader, you're a trader—you'll adapt. And if you don't adapt, you'll have to get another job. People are fearful because this is what they have been doing for 10 or 20 years. On the flip side, you have young guys out of college who don't even know or care what a pit is—all they know is looking at screens. With technology comes change.
Also, I haven't been convinced yet that the market will become totally electronic. If you look at contracts where there's no local cash market, the most successful is the Bund future—big volume, low volatility. But if you look at the DAX, people think you're crazy if you do more than 10 contracts—there's not enough liquidity. In the absence of a cash market, I think we'll always need locals to provide the liquidity needed to back up institutional inquiries.
DS: What should institutional traders know about how orders are filled?
LB: I think the biggest problems institutions have with futures markets are volatility and the way the market flows. It doesn't work like the cash market. When they want to buy 20,000 or 30,000 shares, they can make a phone call and know within a half a dollar where they're going to fill it.
Another big problem is that they believe the quality of their fills and the way their orders are executed is some sort of conspiracy between the order-fillers and the locals in the pit trying to rip them off. Which is just not true. There's a delicate arrangement between order-fillers who make a living protecting you, the institution and your customer.
|Institutions believe the quantity of their fills and the way their orders are executed is some sort of conspiracy between the order-fillers and the locals in the pit trying to rip them off. Which is just not true.
When I was an order-filler, I had a lot of business: all the big companies. I wasn't in the pit reading a newspaper waiting for orders—my head was always in that pit. I knew where the big locals were; I knew if they were short or long. As the market was moving up, I'd hear the orders. If I had 500 to buy and I knew one guy was long, I'd go to him and tell him that, and he'd let me have, say, 100. I knew where people were positioned.
As an order-filler, you're in there in a pit with 500 people and you're trying to do the best job possible for your customers so that you can maintain them. But you're also in an arena where guys are putting their own money on the line and providing liquidity. And if you're too violent in the way you handle these guys, they're going to be violent in the way they handle you back. If you try to bury them with large trades, they'll bid them up on you. It's a delicate relationship between the people in the pit and the people who are executing the orders. You try to have an orderly market and get your business done and coexist peacefully.
DS: How do you know how good your order-filler is?
LB: You can tell who's a good order-filler—guys who have a feel for money and develop a feel for the market. If they're good, they'll know where the big locals are positioned. They've been watching them get short or long, and they're not out to hurt them. It's a peaceful way to get your order done and facilitate your business. They'll ask you what you need. Everyone is trying to act in his own best interest but not hurt others.
There was an episode at the Merc about 10 years ago when firms started cutting rates and putting younger people in to fill orders. When they cut their rates, all the quality guys stepped down. If you're going to be a trader, you don't need to take all that risk for a dollar a contract. Sometimes people get what they pay for.
DS: Anything else institutions should know about this market?
LB: They have their own reasons for why they're buyers or sellers. But it appears to me that when they come in, they all come in together. It's funny because you can see them coming. It's like a herd. And we're going to get out of the way! We're going to wait till it gets to a level where we'll be able to pick 'em off cheaper!
Maybe they're all using the same research. One thing that really mystifies me is some of the models that people from the institutions buy. I look at the research we've developed, and I'd put it up against anybody's. Among the institutions, everyone thinks they've got the Holy Grail; and here they are using something everyone else is using. It's the corporate mentality.
As individual traders, we're down there fighting for survival every day of our lives. We're not trading bank money or institutional money; we're trading our own money. So we've developed good survival techniques. I often think some of the institutional bank traders and hedge fund managers should have to trade off their own money before they trade for banks. That would show who has the grit and fortitude it takes to be a trader.
This bull market has made a lot of people think they're a lot smarter than they are. They keep buying it every time it goes down, and then it recovers. It's bailed a lot of people out. I think that's why on the retail side we had such a big growth in on-line traders. Once they've got enough capital and they're smart enough, they use their margin to buy stock—especially the tech stocks—then they get out of it at a profit and they say: "Oh my God. I'm a genius!”
It's astonishing to see how underqualified some of the people are who are doing this. There are traders out there who are managing billions of dollars who have never seen a down market. I was around in 1987; I saw the way everybody thought the world was coming to an end. And I think we are going to see another correction; I don't think it will be the end of the world, but we'll see who has the grit and fortitude to stick it out.
What I tell my traders—and what I preach on the web site—is that you have to develop a plan. Trade for success, not money. Trade for your plan. Know your entry point, your stop point, and know when you are going to get out. That's what you develop first; the money comes second. Always worry about your losses first, because the losses are what will take you out of the business, not your profits.