Who Makes Money in Wall Street and How

It is interesting to see the diversity of methods aimed to generate income in the trading scene. Whether it’s mathematical trading or value investing, there are countless methods out there. This post aims to review some of the most common methods used in each area, and it’s most well known earners.

Mathematical Trading

What is it: After Black and Scholes found the formula for pricing an option, it was becoming clear that mathematical trading will become a major influence in the financial scene. What is known now as Financial Engineering, has become very popular among university students. The mathematical sophistication is constantly increasing, and people who work in this industry are known as “quants”. The most famous “quant” is probably Emanuel Derman, who also published a book titled “My Life as a Quant: Reflections on Physics and Finance”. In these days, most of the financial firms hire quants.

Notable Quant Oriented Firms

D.E Shaw

Founded by David E. Shaw. Having a Ph.d in Computer Science could not have hurt Shaw. He made a fortune building automated trading systems which exploited anomalies in the stock market. Fortune magazine referred to him as “King Quant”. The firm manages approximately US $29 billion in aggregate capital.

Employment opportunities at D. E. Shaw are known to be extremely competitive. A notable past worker at D.E Shaw is Jeff Bezos, the founder of Amazon.

LTCM

Long Term Capital Market was a hedge fund founded in 1994 by John Meriwether. It had Myron Scholes and Robert Merton on its board, two Nobel Prize Winners! At its peak, it made about 40% return for its investors. After being heavily leveraged, it went bankrupt.

The LTCM example teaches you that no matter how smart you are, there are some things that are out of our reach. A good book on LTCM is “When Genius Failed: The Rise and Fall of Long-Term Capital Management”

Speculating

What is it: Speculating is simply having a philosophy about the market, and acting accordingly.

Notable SpeculatorsGeorge Soros

Arguably the best speculator of all time. Soros is known by his concept of reflexivity, a concept you can read more about in his book, The Alchemy of Finance: Reading the Mind of the Market

Whether is theory is true or not, his record proves it. In Black Wednesday (September 16, 1992), Soros rose to fame when he sold short more than $10 billion worth of pounds, which eventually caused the Bank of England to devalue it’s currency. He earned an estimated US$ 1.1

Although not active anymore, Soros is the prototype of a speculator.

Victor Niederhoffer

Although he went bankrupt twice, Niederhoffer is still considered a top speculator. In 1996, MAR magazine ranked him the number one hedge fund manager in the world. Mixing his philosophical ideas about the market with statistical methods, his new Matador Fund, reportedly returned 56.2% in 2005!

Niderhoffer has also authored several books which describe his philosophy towards the market. One of them is, Practical Speculation.

Trend Followers

What is it: Trend followers believe that the market exhibits trends, either upward or downward. They strive to find systems to identify the trend and “ride” it to make financial gains.

Notable Trend Followers

John Henry

Manages over $2 billion in client assets. He was born to a farming family and loved baseball from the time he was 9 years old. He has described himself as having average intelligence … and attended community colleges and took numerous night courses but never received his college degree. He is also the owner of the Boston Red Sox.

Bill Dunn

Bill Dunn manages Dunn Capital Management which has a minimum initial investment of $10 million in order to enter. He is considered a legend among trend traders.

Value Investors

What is it: Buying shares that appear under priced by some forms of fundamental analysis, and holding them.

Notable Value Investors

Warren Buffet

Not only Warren Buffet is the most notable Value Investor, he is also the most notable investor in the world! He was ranked by Forbes as the third-richest person in the world as of April 2007, With an estimated current net worth of around US$52 billion!

Joel Greenblatt

Less known than Warren Buffet, Joel Greenblat is chairman of The St. Lawrence Seaway Corporation and a value investment guru. He advocates buying “cheap and good companies.”

He has achieved annual returns at the hedge fund Gotham Capital of over 50% per year for 10 years from 1985 to 1995 before closing the fund and returning his investors’ money!