the Market Truth

A lot of the times, simply having an edge in the markets (such as those discussed in the previous post or those that will be discussed in upcoming posts) is far from enough in order to start making consistent money. Another important factor is one's structural edge - their cost structure, platform quality, as well as calibre of back office support and all other aspects related to one's trading environment.

In the arbitrage game, one must keep in mind that they are competing with other arbitrageurs for the same pennies. The degree to which one can compete is determined by one's structural edge. Almost all arbitrage trading is done at either institutional prop desks which have access to practically limitless free capital (see: Goldman Sachs, old Salomon Bond Desk, LTCM, etc.) and have trading costs reduced down to clearing fees - or close to nonexistant. In addition, these guys usually have access to the best news streams (which can be a very prohibitive cost to the budding new trader or even a seasoned one) or even the ability to automate actively-monitored strategies on their computers which already have almost no latency between them and the exchanges.

It quickly becomes easy to see why it is difficult to enter this game. Through prop deals an individual can seek out high leverage/low or no carry cost deals with relatively low commissions that would allow them to begin to compete in certain trades with relatively larger margins (and subsequently greater risk) such as convertible arbitrage, merger risk arbitrage, or even just stastical pair trading. Throughout any further discussion is it important to understand that this sort of trading is out of the reach of the average joe - one must be able to commit the time required to get licensed and acquire a deal either at a prop firm or a hedge fund which will allow one the best circumstances under which to compete with other similar traders.