Notes - The Prop Traders Chronicles

August 6, 2025

Chapter 1: Eat a Percentage of What You Kill

The book begins by setting the scene of a proprietary trading firm (prop firm), where traders use the company's capital to trade financial instruments. The author introduces the core concept of this business: "you'll only eat what you kill". This means a trader's income is directly proportional to their profits, and working for a prop firm allows access to experienced traders ("elder hunters") and the ability to trade significantly larger sizes ("exponentially larger prey") than trading alone.

The culture of prop trading is depicted as inherently revolving around profit and loss and the accumulation of money, which is loud and clear, especially when traders like Jack experience losses. Jack, a senior trader, is an example of a profitable trader who tolerates profanity on the trading floor because of his consistent, significant profits.

The author, Francis Chan, shares his personal motivation for entering the financial markets, describing it as an unexpected fascination and a way to pursue something contrary to expectations. He grew up in a small town but aspired to work in major financial cities like Toronto and New York. He notes that a trader's income, while potentially large, can be inconsistent and relies on individual ability combined with "random luck," such as being in the right place at the right time to capitalize on market structures.

Chan's initial preparation involved extensive reading on retail trading concepts such as "take your losses and let your profits run," accepting losses as business expenses, technical analysis, discipline, and psychology. However, he soon realized that these traditional educational products did not adequately prepare him for the realities of proprietary trading.

The author explains that non-bank prop firms, particularly those he discusses, play a crucial and often misunderstood role for both beginners and experienced traders. Regulatory changes, such as the Dodd-Frank Act in 2010, led to major investment banks eliminating their prop trading desks, pushing many former bank traders to non-bank firms or hedge funds.

Many Canadian prop firms specialize in a specific style of frequent, manual, high-volume day trading, known as scalping, where trades are typically held for 15 seconds to two minutes. This differs from fully automated High-Frequency Trading (HFT) algorithms. Key advantages of joining a prop firm include access to significant capital, exposure to diverse trading styles, and extremely low institutional commission rates compared to retail brokerages.

Swift Trade Securities, the firm where Chan began, is highlighted as a seminal Canadian non-bank prop firm specializing in high-volume scalpers. Their business model thrived on high trading volumes and ECN (electronic communication network) rebates, leading senior traders to receive bonuses for high volume. Swift was unique in that its traders risked the firm's capital rather than their own, which is a defining characteristic of a true proprietary trading firm. Although Swift Trade Securities no longer exists as a corporate entity, its branches continue to operate. Chan initially believed his long-term chart-reading and technical analysis skills, combined with proper psychology and loss-cutting, would give him an edge as a prop trader, feeling he only needed to learn order entry.

Chapter 2: A Swift Reality Check

Upon interviewing at Swift, Francis Chan was asked by branch manager Liz if he played video games. This seemingly unusual question revealed a key insight: experience in video games was considered a practical advantage for frequent scalping, requiring accurate hand-eye coordination, quick reaction time, and the ability to read opponents' cues. In trading, real threats come from human traders and skilled algorithm programmers, not just pre-programmed computer opponents. Adaptation is crucial to navigating rule changes and market dynamics. Other activities like poker and organized sports were also deemed beneficial for developing the right mindset, though not prerequisites.

Liz's interview style was direct, informing Chan that he would likely face 3 months to a year without pay and that most people "won't even make it in this business". This "un-recruiting" tactic is common in prop firms to filter out applicants without genuine desire or suitability for the firm's culture.

When asked "Why do you want to be a trader?", Chan emphasized his desire for control and seeing trading as "one big trade" where his decisions directly dictated outcomes. However, his belief in technical analysis for short-term trading was quickly challenged by Liz, who stated he had things "backwards". She sought to treat him as a "blank slate," especially regarding his "technical analysis crap".

On the first day of training, Liz revealed the daunting statistics: less than 25% of trainees survived their program. She stressed the need to remain calm while unrealized profits and losses fluctuated wildly. A crucial rule for the first week was "Absolutely no charts". This was a deliberate strategy to force trainees to unlearn bad habits, understand market basics, and reduce dependence on charts, which often lead beginners to "see patterns where there are none". Charts, like a thermometer, only show past data and don't reveal all the underlying market factors.

Training focused on core concepts: choosing trading destinations (ECNs, exchanges, floor routes), reading the "tape" (Time & Sales and Level 2 quotes), the difference between adding and removing liquidity, and managing (not eliminating) risk. Chan was introduced to the prop firm's incredibly low fee structures, where costs were fractions of a penny per share, and some ECNs even offered rebates for adding liquidity. This explained why senior traders could scalp tens of thousands of shares for minimal profit per share and still generate significant income.

Observing senior traders, Chan noted their ability to "pull one penny at a time in profit" from highly liquid stocks, with losing trades often being just one penny or breakeven, largely due to minimal transaction fees. Senior trader Ron dismissed long-term strategies as "dreaming," emphasizing that the "reality" of the market is seen directly in the Time & Sales tape. Ron's point was that the market price at any moment reflects only the current consensus on future value, not true intrinsic worth; the Time & Sales, however, shows factual transactions. Opinions and beliefs are entertainment, but risk-controlled reactions to real-time market information provide a consistent edge. This direct interaction with market data, even for human traders, remains viable despite automated systems.

The training also involved a practical exercise: filling out hourly high and low prices for high-volume NYSE-listed stocks, reinforcing focus on the Consolidated Tape System, which reports all transactions. Level 2 quotes (depth of market), showing displayed limit orders at various prices, combined with Time & Sales, allow traders to "see the objective reality of the market". The competition among ECNs and dark pools constantly creates new opportunities, with some venues paying for adding liquidity (makers) and others for removing liquidity (takers). Chan concluded that extensive research into these direct market access tools was vital for understanding the market dynamics and for optimizing entries and exits.

Chapter 3: The Basics of Double Auction Markets in the Real World

This chapter delves into the fundamental mechanics of market liquidity and price formation in a double auction market, such as the stock market. The practical definition of liquidity for a trader is an asset's readiness to be converted into cash. A key concept often misunderstood by retail traders is the spread, which is the difference between the highest bid and the lowest offer. A tighter spread indicates more liquidity (more buyers and sellers posting limit orders).

Unlike an English auction, where prices only rise, a double auction market has two sides:

Bids: Limit Buy orders from potential buyers who wish to buy at a specific price or lower.
Offers (Asks): Limit Sell orders from potential sellers who wish to sell at a specific price or higher. The National Best Bid and Offer (NBBO) represents the highest bid and lowest offer across all venues at any given time.

Market participants are categorized into two major groups:

Liquidity Providers (Makers): These individuals or entities place nonmarketable limit orders (e.g., a buy order below the current best offer or a sell order above the current best bid), thereby "adding liquidity" to the market. No trade occurs until a bid and offer overlap.
Liquidity Removers (Takers): These parties initiate trades by buying at or above the current best offer or selling at or below the current best bid. They "remove liquidity" because their orders are immediately matched against existing limit orders. All market orders are, by definition, liquidity removers.

A crucial insight from the chapter is that markets don't necessarily move up with more buyers or down with more sellers if those participants are only passively adding liquidity. Price movement occurs when liquidity removers actively cross with existing limit orders, or when liquidity providers cancel their orders. It's inaccurate to simply say a stock dropped due to "more sellers" if those sellers were merely adding passive liquidity.

Regulations require the visibly displayed NBBO to be at least one penny apart for stocks priced above $1.00, though hidden or dark liquidity can exist within this spread and still be reported on the consolidated tape. The key difference between a limit order and a market order is that a market order will fill regardless of price movement, while a limit order will only fill at its specified price or better.

The chapter emphasizes that large orders can "overpower" many smaller ones, leading to "breaking a level" (clearing out all bids or offers at a certain price). Displayed liquidity is what is visible on a Level 2 quote, but it's important to remember that not all liquidity is displayed. Large institutions often hide their orders using hidden orders on ECNs, iceberg orders, or dark pools to minimize market impact. However, ECNs with time-price priority (first in line, first filled) prioritize displayed orders, which can incentivize displaying orders despite the loss of anonymity.

Finally, the combination of Level 2 quotes (showing displayed liquidity) and Time & Sales (reporting all executed trades, whether displayed or hidden) allows traders to understand the true market dynamics. This provides the tools for "a poker-like game of showing and hiding one's hand, and strategically choosing a destination to route an order".

Chapter 4: Introduction to the ECN Platforms and Order Routing

This chapter details the crucial role of ECNs (electronic communication networks) and order routing in modern proprietary trading. The most common pricing model for ECNs is maker-taker, where the ECN pays a rebate to liquidity providers (makers) who add orders to their system and charges a fee to liquidity removers (takers) who execute against those orders. ECNs profit from the difference between the fee and the rebate. Some ECNs have, at times, used an inverted maker-taker model, paying rebates for removing liquidity and charging for adding it, which can cause their displayed liquidity to be hit first when a price level breaks. This inverted model was often a marketing strategy to attract active traders, thereby increasing competition and benefiting traders.

The author explains how to interpret Level 2 quotes, which show shortened ECN names, and the consolidated tape, which uses single-letter codes for each venue. He then provides detailed descriptions of the major ECNs and exchanges:

First Generation ECNs

Island ECN (now NASDAQ ECN, code "Q"): Pioneered the maker-taker pricing model in 1997, revolutionizing electronic trading. It's now NASDAQ's main ECN platform.
Archipelago ECN (ARCA, now NYSE Arca, code "P"): Entered the market after Island, initially offering free service, then adopting maker-taker. It merged with the Pacific Stock Exchange (hence "P") and was later acquired by NYSE Group.

Direct Edge Dual Exchanges

EDGA (code "J") and EDGX (code "K"): Originally Attain ECN, rebranded Direct Edge, and became licensed electronic exchanges in 2010. They are entirely electronic and co-located in the Equinix NY4 data center.
- EDGX ("K"): Follows the traditional maker-taker model, competing with NASDAQ and Arca, often with more aggressive pricing.
- EDGA ("J"): Historically used an inverted maker-taker model (paying for removing, charging for adding), which made it the first destination hit during aggressive buying or selling. Since Summer 2011, it has become a deep-discount traditional maker-taker.

BATS Trading Dual Exchanges

BZX (code "Z") and BYX (code "Y"): Founded in 2005, BATS aggressively marketed its maker-taker model and gained significant market share.
- BYX ("Y"): Offered an inverted maker-taker model, similar to EDGA's historical model.

CBOE Stock Exchange (CBSX, code "W")

Launched by the Chicago Board Options Exchange (CBOE) in 2007, it's a fully electronic equities exchange also located in Equinix NY4. Its pricing has varied, from inverse maker-taker to a flat fee model.

NASDAQ OMX BX (NQBX, code "B") and NASDAQ OMX PSX (NQPX, code "X")

These are the rebranded Boston Stock Exchange and Philadelphia Stock Exchange, respectively, after acquisition by NASDAQ OMX Group.
- NQBX ("B"): Historically offered an inverted maker-taker model.
- NQPX ("X"): Offers a unique price-size priority order matching instead of the traditional price-time priority. This means larger orders cut in line ahead of smaller, earlier orders.

The chapter also introduces routing strategies, which are specific instructions traders can give to ECNs for how to execute their orders. Examples include:

DOT I (Island/NASDAQ): Attempts to match internally, then routes to NYSE floor.
DOT D (Island/NASDAQ): Routes directly to NYSE floor without checking electronic books.
ROUC (Direct Edge): A "cost-effective smart routing strategy" that checks internal books, then dark pools, then other exchanges (like Boston), and finally the NYSE floor, returning to EDGX if not filled immediately. These complex multi-step processes are executed in "tiny fractions of a second" and are often mapped to "hotkeys" for rapid "stop out" (exiting a trade).

A significant takeaway is that most modern electronic systems incorporate the ability to look for liquidity in dark pools, highlighting the growing importance of these non-displayed venues.

Chapter 5: Dark Pool Liquidity and Alternative Trading Systems

This chapter focuses on dark pools, which are alternative trading systems (ATSs) designed to allow large institutional traders (like hedge funds) to transact large blocks of shares with minimal market impact and anonymity. Unlike publicly displayed orders on ECNs, dark pool transactions are not displayed prior to execution, though they must be reported afterward. This allows large players to "hide their hand" from the market, preventing immediate adverse price reactions that would occur if their massive orders were publicly visible.

The chapter describes several specific dark pool venues and their unique features:

NYFix Millennium ATS: One of the earliest dark pool venues used by Swift Trade, designed to maximize execution quality and minimize market impact for large traders. It integrates ECN-like matching technology with access to hidden liquidity and offers a "stealth order" type to actively seek out dark liquidity.
Credit Suisse Cross Finder (X-Finder): A popular algorithmic route that seeks dark liquidity across Credit Suisse's network of venues. Orders can be pegged to the midpoint of the NBBO. An "Aggressive Cross Finder" (AX-Finder) also scans publicly displayed venues.
GETCO Execution Services ATS: A large dark liquidity venue created by the proprietary trading firm GETCO. It offers IOC (Immediate or Cancel) orders and typically charges a flat fee.
Knight Capital Group's Dark Pool Routes:
- Knight FAN (NITEFAN): Aggregates both public and dark liquidity, simultaneously sweeping and posting orders to both types of venues for efficient execution.
- Knight COVERT: A dark liquidity-only version of FAN, prioritizing anonymity over immediate execution.
- Knight Match ATS: A registered ATS specializing in micro, small, and mid-capitalization stocks, offering access to order flow from Knight's retail broker-dealer clients with anonymous execution and price improvement.
Level ATS: An independent dark pool created by a joint venture of major financial institutions (Citigroup, Credit Suisse, Fidelity, Lehman Brothers, Merrill Lynch). It offers various order types, including resting orders and SmartBlock orders to control execution rate.
Goldman Sachs SIGMA X: One of the largest dark pool systems, connected to a vast network of Goldman Sachs customers and external liquidity providers, allowing both liquidity provision and removal.

A critical insight from this chapter is the limitations of Level 2 quotes alone. Because orders can be canceled, and large orders can be hidden in dark pools or split across multiple destinations, the Level 2 quote itself is not a completely reliable source of information about near-future price bias. While some large players might show their hand for specific reasons, the rule of thumb is to combine Level 2 quotes with the Time & Sales tape. The Time & Sales, unlike displayed quotes, "will not lie".

Chapter 6: Combining Level 2 and Time & Sales: Reading the Consolidated Tape

This chapter explains the art of reading the tape in modern electronic markets, a skill rooted in combining the Level 2 quotes and the Time & Sales display. Both are essential features of any true direct access trading software; if missing, a trader is likely receiving filtered data rather than a real-time feed.

Level 2 Quotes

The Level 2 provides a live feed of the National Best Bid and Offer (NBBO) and the publicly displayed sizes posted on various ECNs and exchanges. It offers a snapshot of displayed liquidity, meaning it shows only the liquidity that doesn't mind being seen, or is deliberately shown, potentially for deception. The chapter warns that Level 2 can "lie" due to spoofing (posting fake orders to manipulate the market) or orders being canceled at no cost. Traders should view Level 2 as the visible "poker hand" of their opponents, understanding that they might be showing only what they want you to see.

Time & Sales

In contrast, the Time & Sales (the tape) reports all trades that have been transacted on a particular stock, whether the original orders were displayed or hidden. Therefore, the Time & Sales "cannot lie". It appears as a scrolling box of text, typically color-coded: red for transactions at the bid price, green for transactions at the offer price, and white or gray for trades between the NBBO (midpoint trades).

Each line on the Time & Sales provides crucial information:

Did the transaction occur on the bid or the offer price? This is indicated by the color.
Which venue did it execute on? This is identified by the letter code (e.g., "J" for EDGA, "P" for Arca, "Q" for NASDAQ, "Z" for BATS, "D" for dark pools).
How big was the trade size? Traders should look for significantly large trades (e.g., 10,000 shares or millions for liquid stocks; 100-500 shares for illiquid stocks), as small transactions can be insignificant or even used for deception.

A common misconception debunked is that green prints mean "buys" and red prints mean "sells". Every transaction involves both a buyer and a seller. Instead, the color indicates which side the aggressors are hitting. A red print (transaction at the bid) is bearish because a standing bid has been aggressively eliminated by a seller. A green print (transaction at the offer) is bullish as an offer has been eliminated by an aggressive buyer.

The chapter emphasizes that to get a full picture, both Level 2 and Time & Sales must be watched together. The training advice given was not to "read it" line by line, but to "pay attention to the motion of it," its speed, and the "big trades". The practice of "painting the tape" involves traders purposely splitting larger orders into small ones to create the illusion of more buying or selling pressure, though these small, sacrificial trades are distinct from genuinely large prints. The combination of Level 2 and Time & Sales creates a "poker table scenario" of the market, essential knowledge for any market participant to optimize entries and exits and avoid being "blatantly ripped off".

Chapter 7: Week One on Live Trading

The author recounts his "honeymoon period" during his first week of live trading at Swift Trade, scalping General Electric (GE) with apparent ease. He attributes this early success to a combination of beginner's luck, optimal market conditions, and a mindset shaped by nervous determination.

Basic Trading Style Taught at Swift

The core strategy involved:

S&P 500 index futures tape as an indicator: Used as a "last-step confirmation signal" for scalp trades, as it correlated strongly with GE, a large conglomerate.
Tape Reading Fundamentals: The main criterion for entry was observing GE's price moving down one or more pennies, with repeated red prints on Time & Sales and shrinking bid sizes on Level 2 across multiple market centers. This indicated selling pressure.
Entry Point: When the selling paused, and a bid at a lower price showed signs of holding, Chan would place a limit buy order on a maker-taker rebate-paying ECN like Archipelago, aiming to collect a rebate and get a favorable fill. A new wave of green prints on the S&P futures tape served as final confirmation.

After entering a trade, three scenarios were common:

Bid exhausted: The underlying bid (often an iceberg order) would finally be absorbed, and the NBBO would break lower. At this point, the author would look for an exit.
Bid holds briefly: If the bid looked like it might exhaust soon, the author would "punch out aggressively" (sell to the bid) on a nearly free route like NYFix Millennium.
Ideal scenario (momentum shift): A large number of new bid orders would come in, joining the bid on the same or other ECNs. In this case, the author would aim for a one-penny profit by posting a sell order on the offer, or hold for two or more pennies if short-term momentum seemed to reverse.

The most common outcome was scenario #1, often resulting in either a one-penny loss (with commissions largely offset by the entry rebate) or a breakeven trade that was net positive due to receiving two rebates (one for adding liquidity on entry and another for adding liquidity on exit at the offer when the price bounced). Liz, the branch manager, strictly enforced a maximum loss of two pennies for scalping GE, emphasizing that average losses should be near breakeven.

Following the first week of consistent profits, the branch owner, Darrell, invited Chan and another trainee, Joey, to dinner, a sign of their success. The "no charts" rule in the first week was critical, forcing trainees to focus entirely on Time & Sales and Level 2 prints, though Chan later reflected that the profits were also augmented by the extreme concentration induced by this pressure. His consistent profitability led to a "promotion" to trading 200 shares the following week, with share size gradually increasing with consistent performance.

During his second week, Chan took a planned trip to New York City, where he first visited the NYSE building and met Anna, who would later become his fiancée. Upon his return, he found that a section of the ceiling above his usual trading seat had collapsed due to a leak, an incident that coincidentally occurred while he was visiting the NYSE in person. He viewed this as a vivid reminder of the role of random chance in life and markets.

Chan began to diversify his scalping to other stocks like Time Warner (TWX), Pfizer (PFE), and Advanced Micro Devices (AMD), learning the distinct "personality" of each stock through Level 2 and Time & Sales. Swift's risk model was stringent: a maximum daily loss for trainees ($25 initially), and a rule that traders could only lose half of their locked-in daily profits, essentially acting as a trailing stop-loss for the firm. Loss-limiting exits were always manual, not through automated stop-loss orders.

Joey, another trainee, quit because Swift's high-volume scalping style did not suit his personality, despite his prior success as an options trader. This highlighted that this specific scalping style is not for everyone and tends to either fit a trader's personality immediately or grate against them. Chan, despite facing the grim statistic of "less than 25 percent" survival rate for trainees, consciously pushed himself, not aiming to be the most talented, but to overcome the odds through disciplined execution and psychological manipulation to suppress natural reactions to wins and losses.

His second week saw a dip in performance, with break-even days, which he attributed to overconfidence and a loss of focus after initial success. He realized that for a scalper, even a transient loss of focus could have a huge impact on the bottom line. This experience solidified Swift's model of favoring "fresh minds" over those with intermediate trading experience who might carry "baggage" from other styles.

Chan's psychological development as a trader benefited from two key aspects of high-volume scalping:

Intimate familiarity with market microstructure: Direct interaction with the markets fostered a deep understanding of order routing, destination selection, and intraday dynamics that charts alone could not provide.
Rapid increase in per-transaction trade size: Scalping demands progressively larger sizes for economic viability. Liz pushed him to trade as calmly at 5,000-10,000 shares as he did at 100 shares, emphasizing the need to "not think of it as money" and to avoid looking at the P&L display during trades. While risking the company's capital might seem to reduce personal psychological pressure, the mental effect of seeing large P&L swings on the firm's books was still significant.

Chapter 8: Losing $30,000 in Under a Minute

Author's Psychological Development

As the author gained momentum in high-volume scalping at Swift Trade, he grew more comfortable with increasing his per-trade size. He recognized his ability to manipulate his own psychological tendencies, effectively refocusing his reactions to winning or losing trades. This involved reinstating a controlled sense of pressure, similar to the initial "no-charts" rule during his training, which proved effective for his psychological predisposition and maintained consistent profitability.

Jack and Gordon's Dark Pool Gaming Strategy

Senior traders Jack and Gordon, having mastered scalping as a core strategy, began diversifying into other methods. They treated their high-volume scalping profits as their base income, supplementing it with new strategies as potential bonus pay, which also served to hedge against significant downsides if new strategies failed.

Their new focus involved exploiting weaknesses in the then-primitive algorithms of dark pool systems. The primary purpose of dark pools is to facilitate transactions of large amounts of shares with minimal market impact and visibility. However, Jack and Gordon found a way to expose the "hidden hand" of large market participants using these systems.

How the Strategy Worked

The strategy, also known as "gaming the dark pools" or "predatory trading," aimed to locate large orders resting in dark pool systems and play the market against the large institutions that placed those orders. Traders would place small "test" orders (e.g., less than 1,000 shares) on dark pool routes to identify potential large blocks of resting orders, which indicated significant buying or selling interest.

For instance, if Jack's small buy orders were immediately filled, it suggested a large seller in the dark pool. He would then aggressively build a short position by "swiping up" the visible bids, effectively consuming the displayed liquidity that the large seller optimally hoped would not budge. By removing visible buy orders, new offers at lower prices would naturally appear, stepping in front of the large seller's hidden dark offer price. This process would eventually force the large market participant to lower their hidden sell limit price, which was often pegged to the visible National Best Bid and Offer (NBBO). Once their orders were sniffed out, the market impact was anything but minimal. In victory, Jack would then unload his massive short position by buying to cover on the dark pool route, with his orders immediately filled by the liquidity provided by the large participant he had located.

Impact and Evolution

This strategy was a "wildly profitable source of bonus income" for those who gamed the early dark pools, effectively "picking the pockets of large institutions". The author describes this as a "hard edge": a market inefficiency exploitable with minimal skill, discipline, or experience, though transient and potentially close to compliance boundaries.

However, as dark pool algorithms became more sophisticated, trading became more difficult for the first generation of "dark pool traders". Some adapted by moving to firms that hired them to develop anti-gaming techniques, while others found new strategies. Those who failed to adapt often disappeared from the business.

Gordon's $30,000 Loss

One Friday afternoon, Gordon, a senior trader, accumulated a massive position in a dark pool play on an illiquid NASDAQ stock just five minutes before the 4:00 P.M. market close. The firm had a strict rule against holding positions past closing, especially for illiquid stocks, which typically have wide spreads during the day that can expand to over 50 pennies, or even a dollar or two, after hours. This meant a large position held overnight would face massive losses.

Liz, the branch manager, ordered Gordon to flatten his position immediately. Panicked, Gordon used every available route to cover, locking in smaller losses by hitting hidden liquidity between the spread, rather than resorting to aggressively hitting the opposite side of the NBBO. He manually selected destinations with great skill, closing out lots. Despite his efforts, at 4:00 P.M., he was still holding a fraction of his initial position. Liz secured approval from head office for him to close the remainder at market after hours. By 4:01 P.M., he was flat, having lost $30,000.

Surprisingly, Liz informed Gordon that the firm would cover the loss, and his account would be reset to zero for the month. This was possible because Gordon had a strong track record, and the $30,000 loss was a small fraction of his year's earnings. The author notes this as a "small fee to pay for a big lapse in risk management," emphasizing that most traders learning comparable lessons lose much more, often their own funds. The experience also highlighted how profits from "hard edges" like dark pool gaming are often necessary to cover living expenses during "lean years" when only "soft edges" are available.

Chapter 9: Trading with a Real Edge

The Concept of an Edge

Many struggling traders constantly search for a single, elusive "holy grail" strategy, but the author asserts that "there's no single strategy, no single edge that can be exploited forever.". Instead, he explains that there are many types of edges that come and go, which is sufficient for a full-time trader to make a living. The key is to constantly adapt, find, and develop edges that work in the current market conditions, and be ready to find new ones when existing edges weaken.

Hard Edge vs. Soft Edge

The author distinguishes between two types of edges:

Soft Edge: This is the typical goal for most traders and forms the foundation of most full-time traders' core strategies, including those of many hedge funds. A soft edge has a relatively small mathematical advantage, often only 1% to 5% above a raw 50-50 bet. To successfully exploit a soft edge, a trader requires a very large dose of discipline, consistency, and skill. If a strategy's edge is merely "soft," the necessity of these traits is greatly magnified.
Hard Edge: A hard edge is a discovered market inefficiency that can be exploited by almost anyone, even those with minimal skill or experience. These are far rarer but should be exploited as much as possible when they appear. While hard edges are typically not illegal, they often operate "on the very edge of the cliff of compliance" and are likely to be outlawed or circumvented within a few years. It's crucial not to base an entire career on a single hard edge, as they are inherently transient. Diversifying strategies is essential.

Strategy Testing and Transient Edges

The author challenges the notion that a strategy must be backtested over decades of data to be worthwhile. He argues that a strategy's effectiveness in historical data doesn't guarantee future success because markets change and evolve. As a day trader, he advocates for exploiting "transient edges" – patterns or statistical likelihoods that have been profitable in recent months or less, even if they aren't robust enough for long-term consideration. These can provide "short-term paychecks". The advice is to test hunches on small, recent data samples, coupled with good risk management to protect against excessive losses.

Ultimately, traders should be honest with themselves about the type of edge they are trading (hard or soft) and adjust their risk and approach accordingly. Don't be overly cautious due to past failures of seemingly robust strategies, nor be "trigger-happy" ramping up risk for unreasonable levels.

Basic Method of Scalping: Reading Level 2 and Time & Sales

The U.S. equity markets enforce a minimum one-penny spread for displayed National Best Bid and Offer (NBBO) on stocks priced above $1.00. However, this rule does not apply to hidden or dark liquidity. Trading the midpoint of the NBBO, facilitated by hidden liquidity, can itself be a soft edge or a component of a hard edge.

The core of scalping involves "getting on the train" when the market is heading in a desired direction. This is achieved by combining Level 2 quotes (showing displayed bids/offers and their sizes) and the Time & Sales display (the "tape," reporting all executed trades).

Interpreting Market Signals

Level 2 quotes show the depth of market and the current bids and offers from various Electronic Communication Networks (ECNs) and exchanges. However, Level 2 can be manipulated through "spoofing" (faking interest) or by orders being canceled, so it doesn't always reflect true intent. Treat Level 2 as a poker table: participants may only show what they want you to see.
Time & Sales (the "tape") reports all transacted trades in real-time, regardless of whether original orders were displayed or hidden. "The tape will not lie.".
- Color-coding: Red prints indicate transactions at the bid price (bearish for that level), while green prints indicate transactions at the offer price (bullish for that level). White/gray prints are for midpoint trades.
- Venue and Size: Prints include the venue (e.g., J for EDGA, P for Arca, Z for BATS) and trade size. Large trade sizes (e.g., 10,000 or millions of shares on highly liquid stocks) are significant; small transactions (e.g., 100 shares on BAC) are often insignificant and can be used to "paint the tape" (split larger orders to create illusion of pressure).

Identifying Micro-Term Trends

A significant micro-term trend is indicated when:

Bearish: A large number of red prints hit the tape repeatedly, and the number of displayed shares on the bid (Level 2) shrinks. This indicates aggressive selling pressure.
Bullish: A large number of green prints hit the tape repeatedly, and the number of displayed shares on the offer (Level 2) shrinks. This indicates aggressive buying pressure.

These "waves" of aggressive orders signal micro-term trends that are invisible on traditional price charts, as they occur before the price itself moves. They show "what is about to happen before any chart in the world can register that anything has happened at all".

Liquidity Interaction and Fees/Rebates

When anticipating a move (e.g., bearish scenario), aggressively selling to the bid (or buying from the offer in a bullish scenario) makes a trader a liquidity remover and typically incurs an ECN fee. Conversely, the party on the opposite side (liquidity provider) receives a rebate.

Scalpers must balance predictability with order fill ability and ECN fees/rebates.

Rebate Trading: A major asset. ECNs often pay a rebate (e.g., $2.00-$2.50 per 1,000 shares) for adding liquidity (placing limit orders that don't immediately execute). This allows for a "net positive" outcome even on break-even trades.
Inverse Pricing Models: Some ECNs have reversed the maker-taker model, paying rebates for removing liquidity and charging for adding. This theoretically allows scalpers to jump on obvious moves. However, these venues are quickly "consumed" by other participants once the direction is clear.
Cost Savings: Even longer-term traders should use tape reading and destination selection to optimize entries/exits and reduce transaction costs by aiming for rebates instead of paying fees.

Strategy Diversification in Scalping

High-volume scalping itself is not a single strategy but a group of short-term techniques.

Some scalpers enter passively (adding liquidity) and exit aggressively.
Others enter aggressively (removing liquidity) and exit passively or aggressively on a well-priced ECN.
Advanced scalpers may layer orders around a price range to continually collect rebates for adding liquidity, adapting their net position as orders fill. This exposes them to "Black Swan risk," so diversification with other strategies is crucial.

The author emphasizes that understanding micro-term market dynamics, as learned through tape reading, is basic knowledge for any market participant. It provides crucial insight into seemingly insignificant price movements on charts, revealing the underlying activity and profit/loss.

Chapter 10: The Psychology of Profitable Trading

The True Role of Psychology

While often highly emphasized in trading education, psychology alone cannot magically transform an unprofitable trading strategy with negative expectancy into a wealth-building machine. Instead, it plays a significant, yet often misunderstood, role at specific points in a trader's career:

Less Discussed Psychological Issues

Outsized Profits: Traders unaccustomed to significant income (e.g., $15,000 per day) may experience subconscious guilt and self-sabotage. The author advises that since no profitable strategy retains its edge indefinitely, traders should pounce on current edges and save up.
The "Rich Neighbor" Effect: Even if personally profitable, a trader might feel like a "struggling failure" if peers in the same room are making significantly more, especially if those peers seemingly disregard risk management rules. This pressure is common but amplified in the competitive environment of proprietary trading.

The author contends that the focus on psychology is often an "excuse for performing poorly" when the underlying strategy simply lacks a basis in reality.

Psychology and Hard Edges

During periods of "hard edges" (market inefficiencies easily exploited), traditional trading psychology can become almost insignificant. Traders, even those with minimal self-control or experience, could make enormous and consistent profits. However, once these hard edges cease to be exploitable, many traders who began during such periods may exit the business. Those who survive must learn to trade with "plain old soft edges," which is when psychology becomes critical once again.

Purpose and Self-Perception as a Trader

The author reveals his initial motivation for trading: curiosity combined with a desire to master the financial system to gain an "immeasurable advantage". He notes that most traders, including himself, tend to specialize in one aspect of trading (e.g., mental conditioning, charting, tape reading, automated systems) rather than mastering the entire financial system.

He then draws a parallel between trading and life, particularly within modern North American culture. He suggests that society often separates "belief" as a social declaration from "belief" as a literal truth. This distinction can inform a trader's personality:

Those who require absolute confirmation to believe a concept as hard reality may find manual trading incredibly difficult, and might be better suited for developing automated trading algorithms (leveraging programming and statistics skills).
Those who tend to accept all suggested concepts may find manual trading less challenging, but must be cautious about their information sources. The optimal approach, though imperfect for humans, is a balance between the two.

Embracing Uncertainty and Challenges

The world and markets are inherently uncertain. Success can stem from "streaks of dumb luck". Instead of searching for elusive logic or blaming external factors, traders should accept these realities.

A beginner trader's career will involve:

Questioning fundamental beliefs about the market.
Experiencing overwhelming emotions that cloud judgment.
Moments of "epiphany" that offer new perspectives.
Dealing with individuals who seek to take advantage.

Rather than avoiding these challenges, they should be seen as opportunities for self-improvement. Trading, as a profession, is not about immediate gratification; it's about maintaining curiosity and enthusiasm for solving problems within unknowns, accepting a baseline level of uncertainty. The lessons learned in trading can significantly develop one's view of life and equip one to handle personal challenges.

Author's Futures Trading Experience

After witnessing Gordon's $30,000 loss, the author considered trading futures contracts directly (S&P 500 E-Mini futures - ES, and NASDAQ-100 Index E-Mini futures - NQ), which he had been using as indicators for equities. Liz advised against it, noting limited advantage and single routing destinations (CME) in futures unlike fragmented equities markets.

However, the author proceeded. He found NQ futures contracts to have a "choppy hyperactive motion" compared to the calmer GE stocks he was used to. More significantly, he developed a subconscious fear of loss, likely from witnessing Gordon's incident. This manifested as hesitation in executing trades and exiting too quickly, a shift from his earlier "drive to succeed" to a "drive to avoid pain".

He emphasizes the importance for traders to analyze their own mental behavior patterns during trades: if feelings are closer to panic/fear than ambition/desire for victory, the mindset is not right. For strategies with a true edge, mental state can make "all the difference in the world" in execution. The author eventually admitted "small temporary defeat" and returned to his specialty of scalping high-volume NYSE equities. He advises against over-optimizing strategies that are already working, to avoid disrupting current profitability.

Personal Life Parallels

The author draws further parallels from his relationship with Anna, which progressed rapidly. His frequent border crossings between Toronto and New York became a personal challenge to navigate quickly and painlessly, by answering questions calmly and confidently, even if unusual.

He recounts Anna's family's frequent, dramatic arguments, which he initially found surprising outside of fiction. He noticed a recurring pattern of provocation, resistance, gradual escalation, and eventual all-out conflict. He learned that intercepting the build-up at an early stage could prevent full escalation. He likens this to reading the market: a few prints at a certain price (like early provocations) might not signal a major move, but as prints increase in size and liquidity shrinks (escalation), a "big player" can intervene (like intercepting the argument) to turn the tide.

He concludes that while individual actions may seem like "random noise" to long-term traders, every major trend turn originates from "a few big prints that got the ball rolling," whether human or computer-driven. He reiterates that the most important aspect of trader psychology is achieving the proper perspective of trading within one's career and life, looking for parallels and continuously seeking new strategies that leverage personal strengths.

Chapter 11: Choosing a Proprietary Trading Firm

Transition from Swift Trade

The author left Swift Trade Securities on good terms, even receiving a rare offer of a salaried position. His reasons for leaving were practical and personal, primarily to facilitate Anna's move to Buffalo, New York, which offered a shorter commute from Toronto than Staten Island.

He received offers from several New York-based proprietary trading firms, some of which offered remote trading options, a feature unavailable at Swift at the time. While he missed the camaraderie of the trading floor, remote trading was ideal for balancing his financial career and personal life.

Swift Trade's Unique Offering

Through further networking, the author discovered that Swift Trade was unique among independent non-bank proprietary trading firms in that it would accept new traders with zero prior trading experience and no verifiable track record without requiring a risk deposit. This offered a valuable service to beginners who might otherwise rely on misinformation from struggling retail traders. While he acknowledged that pessimism towards prop firms is often warranted due to questionable practices, Swift's opportunity for inexperienced traders was a "rare gem".

Hiring Criteria and Risk Deposits

Current non-bank prop firms often require an "impressive resume" for new trainees, typically defined by:

History in competitive sports.
Proficiency in poker or other probability-based games.
Mathematical skills, especially statistics, if the firm specializes in particular trading styles. Business school degrees are generally less relevant for direct trader positions compared to analyst roles.

Some smaller firms do require a risk deposit from beginner trainees. This model allows firms to accept candidates with minimal qualifications, as they are not risking their own capital until the trader proves themselves. While it offers a foot in the door, it also means higher trainee turnover and more intense competition among a larger peer group.

Meritocracy and Collaboration

Proprietary trading is largely a meritocracy: continuous performance is the key factor in retaining a position, and compensation is directly proportional to profitability. While some firms encourage cutthroat competition, the author advocates for building camaraderie and sharing ideas with fellow traders. Sharing strategies can be mutually beneficial, as market conditions change, and a peer's strength might become useful when one's own strategy struggles. From a firm's perspective, this can also act as an "internal hedge" against downside exposure.

Choosing a Firm: Culture and Costs

When choosing a firm, it's crucial to understand its company culture and the management's trading experience, as compatibility can significantly impact performance, especially during challenging market conditions. Some firms display P&L like a scoreboard, while others foster team environments.

Prop firms generally cover costs through software fees, commissions, and a profit split.

Software Fees: Often covered for beginners.
Commissions: Drastically lower than retail brokerages. For active scalpers, $0.001 USD per share ($1 per 1,000 shares) is considered high. Canadian firms often offer rates as low as $0.0002 USD per share (20 cents per 1,000 shares) due to competition and lower overhead, which is rarely seen in New York.
Profit Split: Quoted from the trader's perspective (e.g., 35% means 35% to trader, 65% to firm). Swift started at 35% and increased incrementally. Aggressive offers for experienced traders can go up to 85%.
- Some firms offer 100% profit split, but this raises suspicion as the firm's interests might not be fully aligned with the trader's, relying solely on commission revenue. Due diligence is crucial in such cases.

Due Diligence and Personal Anecdotes

The author advises tracking down current and former traders to gauge a firm's legitimacy and reputation, acknowledging that negative reputations can stem from competitors or failed trainees.

He recounts his personal experience of finding an apartment in Grand Island, New York, with Anna and their friend Bridget. Due to Anna's poor credit and his Canadian citizenship, Bridget graciously signed the lease, a significant "bet" given her own financial situation. The author views this as a parallel to taking a large trade, emphasizing Bridget's credit risk. The period (February 2007) was one of market optimism, with the S&P 500 reaching new highs, and skepticism towards predictions of a mortgage crisis. The author reflects on the later, unexpected correlation between this personal "perfect" period and the historic market crash of 2008.

Chapter 12: Strategy Diversification

Joining CTNY

The author joined CTNY, a rapidly expanding proprietary trading firm known for aggressively poaching profitable traders, particularly former Swift Trade senior traders, by offering highly competitive terms. Jack, a senior trader from Swift who had caused damages with his aggressive antics, was among those recruited by CTNY as a remote trader.

The author found CTNY's offer, with its aggressive terms for remote trading, to be the most tempting. Although he was a Canadian citizen, CTNY arranged for him to officially trade under one of their Canadian branches (a separate corporate entity), even if he physically worked from New York.

Advanced Training Program

CTNY's two-week advanced training program was optional and free for experienced traders like the author (though it later became fee-based for beginners). For former Swifties, it was less about new basics and more about adapting to the differences between CTNY's Sterling Trader Pro software and Swift's in-house Prosper Pro platform. This was akin to an American visiting Toronto: many similarities, but also subtle, arbitrary differences that take getting used to.

The training class was much larger than Swift's. The head trainer, Jared, was a former high-volume scalper who had diversified into statistical correlation trading and traditional long-short pair trades for overnight positions (which Swift strictly forbade). Jared's no-nonsense approach included immediately filtering out trainees who showed complacency or overconfidence. He emphasized that "Confidence is fine... But never become complacent with success or yourself... The moment you think you've got the market right in the palm of your hand, it'll break free and bite your whole damn arm off.".

Training Content and Trader Dynamics

Jared's training focused on key concepts:

Destination Selection: He explained that there's no single "best" ECN, likening it to finding the "best restaurant". The choice depends on the situation (e.g., getting filled quickly on EDGA by paying a small fee vs. waiting in a long line for a rebate on BATS).
ECN Fees and Rebates: He discussed how inverted maker-taker pricing models (e.g., EDGA at the time, paying rebates for removing liquidity) theoretically allowed scalpers to profit by reacting to obvious market direction. However, in reality, such venues' liquidity would disappear quickly due to competition. These venues are still useful for other strategies or for one leg of a pair trade where aggressive removal is needed.
Excel for Strategy Testing: Jared taught using Microsoft Excel for basic statistical research and testing trading strategies. This simple approach, though "child's play" for quants, led to multiple profitable methods on the trading floor.
Original Strategy Design: Trainees were encouraged to design and test their own strategies, starting with small data samples and potentially scaling up with live, small trade sizes. Jared stressed that profitable strategies are not universal; they often exploit nuances of specific markets.

The class included various personalities, such as Beth, an intelligent academic who struggled with practical trading, and Erin, an experienced former Swiftie who had adapted to market changes. The author, as part of the male majority, noted the dynamic among the few female traders, who often achieved higher success rates despite being a minority. He bonded with Erin over their shared experiences at Swift, discussing market changes like Reg NMS, the NYSE hybrid market, and evolving dark pool algorithms.

Chapter 13: Volatility and the Crash of 2008

Currency Volatility Strategy

Trading remotely from Grand Island in the slow bear market of early 2008, the author developed a strategy based on Jared's models, capitalizing on the daily volatility of the currency markets, which became particularly effective over the summer. This was a "transient edge," not a long-term robust system, and was intended as supplemental income. It was designed to contain losses and prevent long-term bleeding.

The strategy operated on the assumption that volatility tends to drop in summer and increase by September and October. It exploited the volatility of major currency pairs around the 9:30 A.M. ET open of the U.S. equity markets. In the summer months, the currency markets often establish most of their daily range during this period of increased volatility. The strategy involved layering orders in the opposite direction of initial moves to catch a predictable 50% retracement. This was theorized to be due to low summer volume and large market makers needing to flatten their counter-trend exposures, pushing the market back. The author emphasized that the strategy's effectiveness and profitability were more important than the underlying reasons.

Mindset and Market Changes

The development of this strategy highlighted the importance of not focusing too much on "fear, uncertainty, and doubt" when developing trading strategies. While long-term backtesting is valuable, it doesn't guarantee future profitability as "Markets change and evolve.". Simple ideas, if coupled with decent risk management, can be highly effective in extracting income.

The author had a plan to stop running the currency strategy by September 1st due to seasonal changes in volatility. Psychologically, it was difficult to stop a profitable strategy cold turkey, so he compromised by reducing his trade size instead.

The Crash of 2008 and Personal Turmoil

During Black Week, which began on Monday, October 6th, 2008, the author was visiting New York City's tourist attractions. This long-awaited vacation was tragically followed by his personal life spiraling into a "black hole of worst case scenarios" with brutally coincidental timing, mirroring the market's climax. His relationship with Anna deteriorated, marked by her deliberate creation of conflict and the eventual discovery of her infidelity. This also led to the strain and loss of close friendships.

The author reflects on the profound correlation between his personal turmoil and the Fall 2008 market crash, an unlikely parallel he never expected. This period forced him to question his core ambitions. He took vacation time to mentally "cut losses and move on to the next trade" in his personal life, realizing it took longer than in trading. He considers himself lucky to have survived both the market chaos and to have repaired significant parts of his personal life, particularly strengthening his friendship with Bridget. He emphasizes that real-life experiences can be instrumental in a person's development as both an individual and a trader, preparing them for future challenges, especially unexpected "black swan events".

CTNY survived the increased volatility of Fall 2008, possibly due to internal hedges, senior trader profits, or luck. Erin, a fellow trader, suffered significant losses during this period but quickly adapted, recovering and outperforming in the following months, exemplifying how survivors adapt to unpredictable conditions and black swan events. The author concludes that reality offers no fairy tale endings; the best one can do is adapt, turn disadvantages into assets, and remember that no single loss means the end of the world.

Chapter 14: Building Blocks of Trading Strategies

Post-Swift and CTNY Developments

Upon returning to Toronto, the author noted that fierce competition among proprietary trading firms in Canada had created an optimal environment for traders, with commission rates as low as $0.0002 USD per share (20 cents per 1,000 shares), often with full ECN rebate pass-through, becoming common for experienced traders.

The author shifted his focus to a combination of statistical arbitrage (stat arb) strategies and dedicated time to learning programming languages (VBA, C++, C#) for semi-automated trading systems. He stresses that tape reading remains an integral part of trade entry and exit, whether the logic is automated or manual. Tape reading offers a real-time, live view of markets, a crucial alternative to charts that only show the recent past.

Building Blocks of Strategies

Surrogate Market Making

Many non-bank proprietary trading firms employ strategies that mimic market makers. This allows traders to be highly active in the markets, increasing their bargaining power and potentially qualifying for lower commission rates and ECN rebates even with direct access brokerages using their own capital. The main challenge is adverse selection, but creative solutions can minimize this.

Concept: A basic example focuses on earning ECN rebates rather than paying fees.
Hedging: This strategy often involves some form of hedging, such as a core position in a correlated stock or index ETF, to reduce risk. It's a less-than-perfect protection, not a risk elimination.
Pair Trade Variation: It can be seen as scaling in and out of one leg of a pair trade, collecting rebates while limiting losses.

Layered Position Sizing

A common limitation for beginner traders is their restricted position size. As traders develop, scaling up becomes crucial for progress, and creativity in scaling into and out of trades contributes to performance. For choppy stocks or certain strategies like pair trades, splitting entries and exits into smaller orders is efficient, allowing for more opportunities to take extra profits.

Auction Strategies

Opening and closing auctions on ECNs like NASDAQ and NYSE Arca determine the opening and closing prices of stocks. Traders can participate by placing orders with specific "time-in-force" settings (OPG for opening, CLO for closing) before cutoff times. These auctions result in a single "cross price" rather than a bid and offer.

Intraday M&A Scalping Strategies

Some firms employ strategies that capitalize on intraday mergers and acquisitions. For example, if a company is offered for buyout at $12.50/share, and its stock typically ranges between $12.30 and $12.45, a trader can scale into long positions around $12.29-$12.35 and take profits between $12.42-$12.44 by adding liquidity on both sides. The primary risk is unexpected announcements that might jeopardize the deal. The success of these strategies often relies on the trader's ability to use basic tape reading techniques.

Pair Trading and Variations

The basic idea of pair trading involves finding two correlated and co-integrated stocks (often in the same sector) and taking a long position in one and a short position in the other, based on which is relatively underpriced or overpriced.

Criteria: Can be purely technical (e.g., price ratio) or fundamental (e.g., P/E, P/B).
Traditional vs. Intraday: Classic pair trading is designed for overnight positions, but intraday opportunities exist. For overnight positions, tape reading can optimize entries/exits and reduce costs. Intraday pair trading on popular pairs faces intense competition from algorithms; more obscure pairs might offer better opportunities.