Who’s most important in the Financial Universe?

by Dec 9, 2016All Articles, Technical Analysis, Education

When we first took Optuma into institutions, I confess that I didn’t have a full understanding about the different professional roles that existed. I’ve always known about traders. We’d focused on providing tools to them for years. I thought all professionals were traders, and they just traded bigger amounts.

It was after getting lots of business cards, and having lots of conversations, that I started to see that each role is very different. I needed to understand all the roles so that I knew what we needed to build to empower each individual. As time has gone on, I’ve seen how this relates to Relative Strength studies and what every trader and investor has to know.

This post focuses on the model I observe at the largest firm we work with. A $2.1T (yes, that’s a “T”) company. What do I love about their model? It’s something that even a part-time private trader can use. Trust me, I’ll show you how. But first we need to explain the motley crew.

The Hero

heroLet’s start right at the centre of the financial universe—the portfolio manager (PM). This is the person who’s taking in all the information and deciding what to add and remove from their portfolio. They’re responsible for those decisions and are answerable to the investors. Those investors are constantly watching their returns and comparing them to what is happening in the benchmarks.

Remember that every portfolio has a prescribed benchmark. There are hundreds of indices that could be used and the most appropriate one is chosen based on the objectives of the portfolio. Obviously the most common are the biggest equity indices.  For example, a large cap equity fund in the US will use the S&P 500 as the benchmark. This means the investors are expecting the equity fund to do better than the S&P 500.

The Minions

minionsSome PMs will execute their own trades, but most will have traders to complete the execution for them. For these large firms, they can’t just put an order for $1.5B through eTrade. They need to slowly feed the trades in so they don’t tip-off the rest of the market about what they are doing. They often take days to scale into—or out of—a position.

The traders are the ones who take the PM’s orders and are on the phone with brokers making the deals (although most of it is computerised these days). Again, they don’t want to tip-off the brokers, so they will break up orders via multiple brokers. If the broker has a Dark Pool (where they match buyers and sellers off the open market), all the better.

Some traders, depending on experience and how much the PM trusts them, are able to have a certain amount of discretion regarding when trades are executed. For instance, if the trader believes the security will have a short-term pull back, they may delay in buying to take advantage of that.

To Buy or to Sell?

buy-sideSo far, we’ve focused on the “Buy Side”. A Buy Side firm is one that has created funds (portfolios) and is investing in the market on behalf of investors. Obviously they don’t just buy, they also sell from time to time. The point is that they are holders (buyers) of securities.

The Sell Side is what the institutional brokers are called. So we have traders on both sides. Buy Side traders executing via Sell Side traders.

It is more complicated than I am representing it. On the sell side alone we have Position, Execution and Flow Traders. For now, we’ll just group them all together.

ramboTen years ago, Sell Side trading floors were loud and exciting. Lots of traders trying to match their buyers and sellers of securities before they sent them to the exchange. Today, post Dodd-Frank, it has become a little more subdued (although I still sometimes come across a noisy floor). These guys have the typical “take no prisoners” attitude. They exist to get the deals done.

Who does the Analysis?

sleuthThis is the job of the Analyst. Both Buy Side and Sell Side firms will have analysts on staff, although the balance is different for every firm.

Firms will have a mix of Fundamental Analysts and Technical Analysts. We could include Quantitative Models here too as they are also a form of analysis. On the Buy Side, these analysts are employed to provide their opinions to the PM. Typically they do this through a rating system of Buy, Sell or Hold.



overload-resized-600On the Sell Side, the firms are vying for the order-flow because that’s how they make their money. In fact, many firms will offer a Buy Side trader a better fill than market price if…

  • they believe they can make more money from the commissions
  • they are holding the other side of the trade and want to clear it
  • they want to get a favour from the PM to secure future order-flow.

One of the ways that Sell Side firms garner favour with the Buy Side is to employ their own analysts. These do a similar job as Buy Side analysts, except they communicate their recommendations through reports and chart books. You’ll see them coming down the corridor—they are the ones running around with their arms full of charts and reports.



Who is most important then?

It’s the portfolio manager. If the PMs would stop buying and selling, the rest of the financial universe would wither away. The traders would have no trades to execute, the analysts would have no analysis to sell, and there would be no market for the rest of us to take advantage of.

The Financial Universe

The whole industry is set up to provide services to the PM and help the PM reach their goals. How does a PM measures success? By outperforming their benchmark on a relative basis. Put another way, a PM wants to load up their portfolio with securities that are outperforming the benchmark so that their portfolio will outperform.

Nearly all the professional analysts whom I have worked with, on the Buy Side and the Sell Side, have a heavy focus on Relative Strength (RS) analysis. Analysts know that RS is what the PM cares about most—so that is what they study. One of the most popular tools we have is the RIC (Relative Index Comparison) because an analyst can switch codes and the tool will use the right benchmark.

Of course there are a lot of other roles and other markets. This was a nice simple way that I used to understand how the biggest funds worked, and what was important to each role.

That’s nice. So what?

What do you think happens when an industry, that is on the hunt for returns, sees a stock outperforming the S&P 500? The analysts spot it and are telling all the PMs about it. The PMs, who want Alpha, decide to add it to their portfolios and the traders start buying. We all know what new buyers mean. The price is going to go up. I would say that RS is one of the biggest drivers of absolute returns. You just need to be able to get in early.

Even if you are trading your own account, you are doing yourself a disservice if you are not considering Relative Strength as part of your analysis. At Optuma, we’ve made that simple by including Relative Rotation Graphs® in every copy of Optuma. You can see a detailed webinar on RRGs here  http://oab.io/vyaje.

Time for more hats!

 hatsOnce I started piecing all of this together, one of the first things that struck me was the advantage that each professional had compared to a small RIA or private trader. The institutional guys get to focus on just one job without the biases of the other functions.

When you are running a smaller RIA or a private account, you are doing all the jobs at once. You are analysing the charts and listening to news. You are thinking about new opportunities within the context of how they fit your portfolio. And when you are ready to make a change to the portfolio, you are the one to try and get the best price and execute.

I know from my own experience that it’s very difficult to be objective when analysing a security that I already have a position in. I’m looking for analysis that’s confirming the position that I have. It’s so important to be able to analyse objectively.

I remember hearing that Ken Gerber, from Lambert Gann, would tell students to have a cap that on one side said “Trader” and on the other “Analyst”, and a mirror on their desk. When they were analysing charts, they would turn the cap so “Analyst” was at the front. When trading, they’d turn it the other way. The aim was to help them remember what they were doing to keep their focus. I would suggest a third setting saying “PM”. Perhaps having three hats would be helpful.

If you can do the following:

  • analyse with no regard to current positions
  • treat the analysis as one of many inputs into your portfolio management  
  • execute based on the needs of the portfolio and not because of your analysis

…then you will have achieved a strong disciplined approach to your own portfolio management. Also remember that Relative Strength cannot be ignored. It’s such a huge driver of the market.

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Mathew Verdouw, CMT, CFTe

Mathew Verdouw, CMT, CFTe

CEO / Founder Optuma

As a Computer Systems Engineer, Mathew started Market Analyst (now Optuma) within 18 months of completing his degree. From that point on, Mathew has made it his mission to build the very best software tools available.

Since 1996 Mathew has been learning about all aspects of financial analysis, and in 2014 earned the CMT designation (Chartered Market Technician). In 2015, he was also awarded the CFTe designation. In 2017, Mathew started to teach the required content for the CMT exams at learn.optuma.com. He is the only person in the world who teaches all three levels due to his broad exposure to all forms of financial analysis.

As someone who has dedicated his life to find better ways to analyse financial markets, Mathew is set to drive innovation in this sector for many years to come.


  1. A. Koos

    Wonderful article, as always, Matt…

  2. Peter Simpson

    Thanks Mathew, I look forward to the Optuma e-mail each Week and always enjoy the articles, which you publish.
    Every Week I seem to learn a little more about the art of trading and getting the most out of the Optuma Software

  3. Charles Brown

    Fantastic article, Matt. It shows the whole business in an easy-to-read overview. Well done!


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