Thread: Introduction to Trading Arcades

The following article written by Martin Duncanson was first published on T2W here on Sept 15th, 2005. It's reproduced here by kind permission of T2W.

What is a trading arcade?

A trading arcade, proprietary trading group or trading bureaux are some of the commonly heard names for a company that provides risk management, additional leverage, professional software and hardware infrastructure, trading facilities with analyst support and sometimes training and capital backing to traders in return for a share of trading profits and/or commissions.

At an arcade, you would typically find a spacious trading room filled with desks: well equipped work area's with high spec workstations, arrays of screens and terminals providing access to market data & depth, quotes, charting, Reuters, Bloomberg, Sky TV and the all important trade execution platform. The name trading arcade probably originates from the fact that the rows of traders facing screens bears an amusing resemblance to a video game amusement arcade full of kids.

The origin of Arcades

With the rapid expansion of electronic trading and the demise of open outcry as many exchanges close their trading floors, a whole community of professional floor traders was on the street looking for a way to salvage their livelihood and duplicate some aspects of the floor trading environment. Many of these former locals formed their own trading firms as they made the transition to the screen trading. These trading firms came to be known as arcades, and since the majority of traders were former pit traders the definition of a local came to include pro screen traders at arcades.

While there is no precise data available on the share of futures trading that Arcades account for, the evidence suggests that it is significant volume. Euronext estimates that independent traders, its term for screen based locals, individuals and firms trading for their own accounts, make up about one-third of the entire universe of people trading on its Connect platform. Trading Technologies, the software vendor used by most local and professional traders claim to account for as much as 50% of the total futures volume traded around the globe.

Why trade with an Arcade?

There are numerous advantages which I will detail below:

• Commission Costs. A professional trader's biggest 'cost of doing business' is the commissions he pays. The primary advantage with arcade affiliated trading is the huge savings that can be made in the costs per roundtrip trade (roundtrip = an opened and closed trade). The total number of executed roundtrips at an arcade can easily number into the millions of trades monthly. The arcade as an entity therefore has huge buying power and can use this to negotiate ultra low commission rates with the clearing firm that a standalone trader could never expect to receive.
  
  As an example: A pro trader might easily execute well in excess of 50,000+ round-turns in a month and pay perhaps 60p per round-turn trade his total monthly commissions paid at that rate would equal £30,000.00. By contrast, a retail trader paying retail brokerage commissions at a company like TradeStation would pay $5 round-turn or approx £2.65 so the same quantity of roundtrips at this rate would add up to a whopping £132,500.00 of commission!! (as a further comparison, spreadbetting firm Finspreads are today quoting a spread of 1.00pts on the March S&P futures equivalent to an incredible $50.00 commission for an equivalent point value trade as the futures contract).
  
  So for every 10p saved in commissions in this example makes an extra £5000.00 in savings/profits for the traders account. Competitive transaction costs are a large part of ensuring a trader succeeds when the trader is scalping from tiny inefficiencies in the market pricing. The arcade will provide additional volume breaks, usually on a sliding scale so that the more volume is traded, the cheaper his commissions will progressively be.
  
  The arcade itself is a business in its own right, providing a service to traders, so the commission rate the arcade will pass to traders will typically include a margin for the arcade as a business. This is to be expected however, and the rate the trader receives will usually be highly competitive as you can see from the above example.

• Infrastructure: A commitment to full-time trading also requires a commitment to invest in the best hardware and software that are available. A trader needs every advantage in a fast moving market and with more traders competing against each other than ever before, you can't expect to be a competitive participant in today's electronic marketplace by using an outdated machine, unreliable software with inadequate screen space and a slow connection. As a result, the initial outlay costs associated with setting up a comfortable, reliable trading desk with access to the best hardware and tools can be very high. The ongoing costs of the best data feed, software subscriptions, maintenance and support can be higher still.
  The buying power of an arcade again comes into play: The high cost of infrastructure such as high quality workstation, multiple screens, datacenter, subscriptions to professional software such as CQG, TT X-Trader and Bloomberg Terminal, in-house computer technicians, multiple failsafe data lines and uninterruptible power backup can all be combined and work out extremely advantageously on an individual cost per trader basis.
  
  The advantages of having the best hardware, software and support at prices unavailable to individual traders speak for themselves and provide the second biggest advantage for arcade trading.

• Support: Many arcades will run an Analyst desk where a market analyst(s) will provide live commentary and interpretation of news and fundamental data. Often these will have sources who can get news releases early and put out trade recommendations before major announcements. Additional backup comes in the form of onsite computer technicians & IT support who make sure you don’t have system problems, and can fix them quickly if you do.

• Environment: Clearly, working in a dynamic environment surrounded by other experienced traders is going to be beneficial to anyone serious about trading. Experienced traders can always give you tips if you are following an arcades in house methodology, and the atmosphere and buzz can help a lot with perpetuating that essential traders mindset. Offices are often a spacious, trendy, well equipped environment with trader comforts such as lounges, rest/sleep zones and playrooms with pool, arcade games and perhaps a sandwich bar.

What does all of the above cost?

The cost of renting a seat and using all of the associated services will vary greatly between arcades, depending on what services they include in your desk/office package. A typical monthly cost might range from under £1,000 for one exchange up to £2,500.00+ for five exchanges or more. For a retail trader or someone uninitiated to professional trading and the costs involved, this might sound expensive but when compared to what a pro trader would have to pay anyway just for using the same software alone, excluding all the hardware, the other support services and the office costs, these sort of costs are usually a very significant saving! As an all inclusive package, a competitively priced desk fee is always a great value deal for a professional trader.

An arcade generally does not make much, if any, money from the monthly desk fee these fee's cover the significant running costs and, if competitive, are not an earner for the company.

How does the profit split work at an Arcade?

Generally, if you as a trader make use of the arcade's additional leverage facilities, either to fund the full margin requirements for an overnight position or for your intraday activities then your agreement with the firm will include a pre-agreed share of trading profits for the arcade. This share will vary depending on the facilities you make use of, but it might be around 10-20% of end of month profits for the arcade.

If you are a fully self-funded trader and you do not use the firms capital, then a profit split does not apply, but if you do make use of the firms capital and put that capital at risk in your trading, then of course the arcade will be entitled to a return for its risk in making that facility available to you.

How does an arcade make its money?

The cost of running the office, providing the equipment, data and software services will be covered by the desk rental fee.

The main income stream will be via brokerage services where the arcade provides ultra-discounted commissions to the trader by means of its combined buying power, and includes a margin for the business in the final roundtrip cost.

Another source of income is via leverage and margining services where the firm will fund or part fund positions, and take a pre-agreed percentage of trade profits in return for its risk.

Lastly, Arcades will benefit from funding and training their own traders to trade the firms in-house methodology and capital.

(continued in next post...)

What are liquidity provider rebates for Arcade traders?

Due to the huge amounts of volume an arcade will execute, the firm will be registered as a liquidity provider with the exchanges that it trades with. Individual traders can benefit from what the exchange calls liquidity provider rebates which is where the exchange refunds part of the exchange fees on a sliding scale based on how much volume or liquidity the trader provides to the markets.

These refunds start from around 5000 lots traded in a month. For a trader doing even average pro volume in a month, the rebate can add up to many thousands, or even tens of thousands of pounds that are credited back directly into the traders account.

Who would use an Arcade?

Trading arcades largely took over as the venue of choice for locals, brokers and professional traders where the exchange dealing floors in London left off when LIFFE closed the pits.

Most traders involved in trading professionally, for a living, or as a broker would find advantages in a trading association with an arcade. For new traders and those who wish to make a start in the trading industry, an arcade is an excellent place to learn many of the strategies used by the pro's and many arcades offer training and funding schemes for graduates.

Are all Arcade traders self employed?

As a majority rule, this is almost always yes, even if trading the firm's capital as a funded trader. Traders will usually be considered as external self employed consultants who make use of the arcade facilities for a fee. There are obvious tax advantages available for prudent traders in this arrangement when considering the sums of money involved.

What about Arcade training and graduate schemes for new traders?

Some Arcades will also train and fully fund a new trader using the firm's capital. Arcades will generally only accept graduates although there are no fixed rules in this regard.

The Arcade will have a particular approach to trading that they know works well and where they can precisely quantify the risk/reward to the business. The trader will undergo an extensive training period, typically lasting several weeks or months. This training will include learning the Arcade's in house techniques and practicing it on an execution simulator. When they can show consistent simulated profits, they will be funded and started on the market for real initially with small size but scaling up as they prove themselves profitable.

Training might take two or three months before live trading at which a new trader may not show consistent profits for six or nine months. He should anticipate being break even or profitable within the first year, and that being the case the second year should be a good year for both the trader and the arcade.

In return for providing the training, risk capital and either a basic wage, or a capped withdrawal from the firm funded account, the new trader will be expected to honour a contract to trade with the firm for two or three years. This way the Arcade can expect to recoup its losses in training the trader, funding his basic wage and trading capital plus cover his initial losses. The profit splits under a training and funding deal will generally be more like a 50/50 split, which for a trader who is being shown how to take consistent money from the market at no risk to his own money is a very good deal.

At the end of the contract, a trader can renegotiate his terms if he wishes to continue trading the firms capital or he may have enough money in the bank to trade as a self funded trader if he wishes to risk his own money.

Demand for these funded trader positions is always high, Arcades have great difficulty selecting from the hundreds of applicants for each new position.

What trading methods do Arcade traders employ?

Professional traders will usually either be directional scalpers or spread traders (nothing to do with spreadbet). Generally, both approaches will be trading large size often for just single ticks by trading off both sides of the bid/ask in the same or different markets.

Spreading is a type of arbitrage approach where the trader is both long and short two similar or correlated markets at the same time. This type of trading qualifies for large margin breaks from the exchanges due to the more limited risk of these positions, so a spread trader can be working orders of 100 contracts for perhaps the same margin as would be required for an outright directional long or short position with just 10 contracts.

What markets are traded?

Depending on the methods being traded, professional traders operate in most all of the worlds futures markets. UK traders might typically follow strategies in the interest rate STIR futures - such as Euribor, or Eurex traded bund, bobl and shatz futures since these markets are all linked and move in similar ways that allow spread trading approaches to work.

Can I trade my own trading method at an Arcade?

If self funded... yes, you can pretty much trade how you like and benefit from the low transaction costs at an arcade. If funded by the arcade, then no, if using their money at their risk you must trade their method because they will have a consistent & proven track record and precisely understand the risk-reward ratio's for a new trader undertaking this strategy.

The good, the bad and the ugly...

Like in any business, be that the direct access brokerage or spreadbet firm you choose to use, or the garage you take your car to, there are the good deals, the average deals and there are bad deals along with the very occasional outright cowboy.

Certainly in the forums and when it comes to professional traders, you generally only get to hear about the bad deals or cowboys when it comes to discussion about arcades because apart from a few helpful Trade2Win forum stars, most traders who have an average or good deal are usually very busy happily making a huge amount of money and probably aren’t going to take much time up writing in great detail on forums about what a good arcade he is at and how much money he makes. Although the opposite certainly seems to be the case.

Don't let this slightly one sided negative press colour your opinion of all trading arcades in general. Trading arcades are designed and exist to cater for a particular kind of trader, just like retail brokerages and spreadbet shops cater for other, very different, types of traders - but for their specific customers the services provided by many arcades are generally very advantageous to them.

As with choosing an SB firm or a retail futures broker any pro trader worth his salt will also have a brain and know how to use it to read the terms he is being offered and ask the right questions to ensure he is getting a good deal from an arcade.

The most important considerations a trader will need to evaluate before joining an arcade are:

• Commissions – generally anything over £1 per round-turn is considered expensive.
• Desk Fee – what is included for your money?
• Contract duration – how long will you be tied in to a particular deal, commission rate or profit share for?

Anyone thinking of joining a graduate scheme as a trainee trader should take their time to read all the threads on this subject in the Trade2Win forums, as this site IS frequented by professional traders who trade at a variety of arcades and there is a wealth of information about what is considered a good deal and at which arcades you can find them - here on this very website.

The future for Arcade Trading?

The legacy of Arcades also being a profitable venture in their own right through taking a profit margin on commissions and desk fee's may not be a scenario that will continue for much longer. Recently Refco Trading Services, formerly an arcade known as Mac Futures slashed their commission rates in response to the launch of a new venture called The Traders Clearing Alliance. The TCA are an association of member traders who operate on a “not for profit” basis – meaning they offer desk fee's and clearing commissions at cost, with commissions being a flat rate and not on a sliding scale. A development like this is going to change the industry forever since no Arcade is going to want to clear trades at cost, and high volume traders ultimately want the lowest costs for their trading. As more traders join the Alliance, their total volume will increase and their costs will fall still further – likely, the Clearing Alliance is set to dominate the entire industry and will almost certainly represent an exciting new development for professional traders.

In conclusion

For professional traders, a trading Arcade can give access to significant advantages and cost savings that you cannot get as an individual trader. For a graduate looking for a career an arcade can certainly be the launch-pad for new traders in a profitable trading career.

This is all true. The arcade is the gateway. I trade Arcade/Prop myself. In the states you need a series 7 at minimum.