The activities of the trading desk include, firstly, principle trading. This is where a bank is entering into a trade using the bank's own balance sheet, so using the bank's own money or own assets, where that trade has been initiated by the client or where the trade is initiated for risk management purposes. The bank is a counterparty to the trade trading in its own name. Agency trading, however, is where the bank is entering into a transaction on behalf of a client. This does not involve the bank's own balance sheet, and it could be that this trade is entered into over an exchange or with another counter body.
Market making is the process whereby a trading desk is quoting prices to other market participants to buy or sell securities at those prices that have been quoted are firm prices not indicative prices. And the role of a market maker is to provide liquidity in a stock. Any trade entered into on a market making basis are using the bank's on balance sheet. So on a principle trading basis.
Outside of trading individual securities there are some larger trade types to be aware of. The first is a block trade. A block trade is a large transaction in a single security executed quickly. This will be traded as a principle trade in the bank's own balance sheet and the bank will then need to sell these shares on in the marketplace. A program trade is a large transaction involving many different securities. All which are traded simultaneously. This may be done for the purposes of setting up an index tracking portfolio and can also be referred to as a basket or portfolio trade. This can be executed on a principle or agency basis.
Looking in a bit more detail of those block trades where an investor is looking to sell a large volume of securities quickly, in managing the risk around that trade the bank has to balance off the problem that if they're looking to sell a large number of securities quickly on the market, which will result in a substantial drop in the stock price, meaning that those securities cannot be sold through a good price on the open market, potentially causing a loss to the bank. The alternative will be to dribble those trades out in a high number of very small volume transactions. But this creates its own problems in terms of administering the trade. In addition, if equity markets generally move up in the time when these trades have been dribbled out this may well lead to a loss to the bank as well. The skill of a trader is to balance these two competing forces of the market price reacting to the trading activity itself, and waiting to trade by opening yourself up to adverse market movements. A trading desk would see a block trade as a good bit of business, because despite the margins on block trades being relatively small, having a large volume of transactions coming through your trading desk is a good thing, because it will enable the bank to move up tables and look like a more efficient operator. However, if those securities are bought from the client to the block trade at a low price, at too lower price, this opens the bank up to the risk that they will not be able to be onward sold into the wider market for a better price. Meaning the bank will suffer a loss from managing the risk around that block trade. So again, a balancing act between winning the business and being able to make a profit from managing the risk around that trade. Before taking on a block trade an investment bank may look to try to find potential investors to take the shares off their hands should they win the business. Equity capital markets may also get involved here to try to identify which clients might seek to engage in block trades in the first place.
