Traders are the little-known heroes of portfolio management. Portfolio managers capture the glory, but often their investment strategies wouldn't be achieved without the skills of traders.
As people like Rex A. Sinquefield, chief investment officer, Dimensional Fund Advisors Inc., Santa Monica, Calif., attest, without keen skills in trading to reduce costs, the small-cap investment strategies of his firm "get killed." Perhaps the balance between attention to strategies and trading needs revision, although certainly investment strategies always will take preeminence.
A new book by Larry Harris - Trading and Exchanges: Market Microstructure for Practioners (Oxford University Press Inc., New York) - might better reconcile that skewed perspective. Mr. Harris took a leave as Fred V. Keenan Chair in Finance at the University of Southern California, Los Angeles, to become chief economist of the Securities and Exchange Commission and director of its Office of Economic Analysis, Washington. He is as well the research coordinator of the Institute for Quantitative Research in Finance, better known as the Q Group. So he knows the institutional investment community, its objectives and obstacles it faces.
In his book, Mr. Harris offers an insightful look at trading, whether for equities, fixed income, derivatives, swaps or exchange-traded funds, and whether in domestic or international markets. It is an engaging read in plain words, interspersed with often relevant and sometimes whimsical vignettes such as why it's illegal to trade futures on onions, or on the dire impact of transaction taxes, or on the Brazilian straddle.
Among aspects in the 643-page book, Mr. Harris discusses trading from techniques to types of practioners, including brokers, specialists, long-term institutional investors, and arbitrageurs; market manipulation; the structure of regulation; and the politics of intervention. He discusses competition among markets, including the mixed success of electronic communications networks like Island ECN and Instinet, crossing systems like POSIT, and other alternative markets like the Arizona Stock Exchange.
Other points he raises include trading liquidity; information asymmetrics, meaning some traders know more about values than other traders; frontrunning; the importance of markets to the economy in efficiently allocating resources; and market bubbles, crashes and regulatory intervention.
Mr. Harris asks why foreign exchange markets have such huge volume, $1.21 trillion on a recent day. The answer is because these markets are "quite opaque," causing "dealers to trade actively with each other to learn about market conditions." He suggests volume probably will decrease as these markets become more transparent.
While he doesn't discuss balancing the credit for portfolio strategies with trading skills, clearly his book shows the financial importance of understanding trading and operations of the markets. One notion of his might sum up an objective of his book for traders, as well as investors who employ traders: To win, you must not just play well, but play better than your opponents.
He offers valuable insight on evaluating both trading cost and investment portfolio performance.
Mr. Harris' expertise in academia and the SEC gives his book a compelling authoritative voice on trading. And it's nice to know someone with his knowledge and disposition is now in a position to influence public policy and rules, especially in this time of dismal markets and ever far-reaching investment vehicles and strategies.