Trader Construction Kit was written as a response to a decade and a half of inquiries from frustrated junior colleagues, analysts, risk managers and support staff seeking the best book to learn how markets worked and how to develop the skills necessary to make the move onto the trading desk. Unfortunately, there was no one resource at the time, so I would cobble together a reading list of a dozen or so texts, a handful of magazine and journal articles, and a movie or three. Some were classics in the field, others somewhat more esoteric, but each illustrated a particular aspect of what it meant to be a successful trader (or, in some cases, an extremely unsuccessful trader). That same list can also serve as the logical extension of the material covered in Trader Construction Kit, building on the methodological framework and expanding the reader’s knowledge base.
The Best Books for Beginning Traders:
- Liar’s Poker: Rising Through the Wreckage on Wall Street by Michael Lewis
- Bombardiers by Po Bronson
- Metal Men: How Marc Rich Defrauded the Country, Evaded the Law, and Became the World’s Most Sought-After Corporate Criminal by A. Craig Copetas
- When Genius Failed: The Rise and Fall of Long-Term Capital Management by Roger Lowenstein
- Rogue Trader by Nick Leeson
- Options, Futures, and Other Derivatives by John C. Hull
- Technical Analysis of the Financial Markets: A Comprehensive Guide to Trading Methods and Applications by John J. Murphy
- Dynamic Hedging: Managing Vanilla and Exotic Options by Nassim Nicholas Taleb
- Reminiscences of a Stock Operator by Edwin Lefèvre
- Market Wizards: Interviews with Top Traders by Jack D. Schwager
- The New Market Wizards: Conversations with America’s Top Traders by Jack D. Schwager
- Charlie D. The Story of the Legendary Bond Trader by William D. Falloon
- Every Hand Revealed by Gus Hansen
The first five books focus on what it means to be a trader, the next three build the technical skills necessary to operate in the market, and the final five act as an extended series of case studies on trading decisions.
Beginning with the first five experiential books:
1. Liar’s Poker: Rising Through the Wreckage on Wall Street by Michael Lewis
Liar’s Poker has probably set more people on the path to the trading desk than any other book (it certainly did, in my case). Liar’s Poker is Michael Lewis’ first-hand account of his time on the New York and London bond trading floors at the legendary Wall Street bank Salomon Brothers in the late 1980s. It is by far the most accessible book on trading, providing a clear, accurate (if slightly dated) perspective on how bank trading floors operate and the types of people that inhabit them. It is also extremely funny. Liar’s Poker is a must-read, particularly for those not currently in the industry or who are unfamiliar with how trading desks function.
2. Bombardiers by Po Bronson
Bombardiers is the fictional account of a group of bond salesmen at the San Francisco office of a global investment bank in the 1990s that are pushed to, and in some cases past, the breaking point by the stresses of the job. Bombardiers most accurately captures the frenetic feel and surreal insanity of a modern trading floor, and does so while managing to be funnier than Michael Lewis’ Liar’s Poker.
3. Metal Men: How Marc Rich Defrauded the Country, Evaded the Law, and Became the World’s Most Sought-After Corporate Criminal by A. Craig Copetas
Metal Men is a relatively unknown book (which used to be all-but impossible to find) that offers a view into the rarely-seen world of commodity merchants operating in an early-stage physical market. The book takes place during the advent of the spot crude oil market in the 1960s and 70s, and offers a wealth of anecdotal information about illiquid, physical trading that is unavailable from any other source. Aspiring traders would do well to take note and apply the lessons to their job search, as developing markets offer some of the best conditions for job creation and rapid advancement, as well as presenting the smallest hill to climb in terms of the established knowledge base.
4. When Genius Failed: The Rise and Fall of Long-Term Capital Management by Roger Lowenstein
In the early 1990’s Long Term Capital Management was home to the most incandescently brilliant collection of bankers and traders ever assembled, deploying state-of-the-art trading technology to generate eye-popping returns and basking in the adulation and envy of pretty much, well, everyone. Then suddenly, impossibly, the firm imploded during a tumultuous six week period in 1994. Lowenstein’s book is a detailed account of the disaster, and a fascinating tale of hubris and poor risk management by a group of individuals that could have, and indeed should have, known much better.
5. Rogue Trader by Nick Leeson
Rogue Trader is the autobiographical story of how Nick Leeson singlehandedly lost $1.4B via a series of ever-larger unauthorized speculative positions while running the Singapore trading operations of Barings Bank from 1992 to 1995. Though it is sometimes criticized as being an overly self-serving interpretation of events, it is worth reading as an examination of how pressure to perform can lead a seemingly normal, relatively grounded individual into a destructive spiral of fraud and illegal activity. It is also an interesting case study of how much an organization can collectively delude itself, ignore common sense, and bend its own rules to accommodate a star employee operating what appears to be an extremely profitable business.
6. Options, Futures, and Other Derivatives by John C. Hull
It is difficult to overstate the importance of Hull’s Options, Futures and Other Derivatives, which is ironic, considering that it is generally referred to as “the bible” of the financial markets. Recently updated in a 9th edition, it is a big, imposing book that has evolved and expanded its scope considerably with each successive iteration. Option trading has a large and extremely complex body of theory, and can be an extremely daunting subject for the uninitiated. Trader Construction Kit presents an introduction to the basics of the options market, standard valuation models, Greek risk measurements, and provides a dynamic hedging example…and even that relatively condensed coverage necessitated by far the largest and most complicated chapter of the book. Hull’s text provides the most complete coverage of the topic available, and offers a clear, comprehensive treatment of the mathematics underlying derivative pricing models and the resulting risk metrics. It should be considered mandatory reading for prospective practitioners, particularly those interested in option-centric careers in derivative trading, transaction structuring, and complex deal origination. This is doubly true for a trader contemplating a customer-facing role at a bank, merchant, or asset management firm, where it is almost impossible to price and hedge deal flow without a solid understanding of option fundamentals.
7. Technical Analysis of the Financial Markets: A Comprehensive Guide to Trading Methods and Applications by John J. Murphy
Technical analysis is the study of chart patterns as a window into market sentiment and trader psychology, and is an extremely polarizing concept in the industry. Some practitioners flatly refuse to acknowledge its predictive utility, while others exclusively employ pattern-based analysis of the market to generate trading strategies. I make the argument in Trader Construction Kit that a hybrid approach incorporating both fundamental and technical information sources is maximally effective, employing technical analysis to refine the trader’s view and provide perspective on the potential magnitude and direction of price responses to the evolution of the fundamental landscape. Technical analysis has an extremely large body of theory, ranging from simple graphical tools to exotic, complex interpretation systems. I believe that the basic trend and pattern analysis techniques can be applied to any liquid product, regardless of market, and therefore have the most predictive utility. Murphy’s Technical Analysis is the benchmark resource for understanding the core concepts of trend, support, resistance, and pattern analysis. The main value in Murphy’s text resides in chapters 4 through 6, where he discusses the basic patterns common to all markets and gives clear, concise interpretations as to why they occur, their significance, and the implications for future price movements. Murphy’s book is also a worthwhile read for those who do not ever intend to employ technical analysis, but who will most certainly share the market with traders that are.
8. Dynamic Hedging: Managing Vanilla and Exotic Options by Nassim Nicholas Taleb
Back in the dark ages, risk management was an obscure mathematical discipline exclusively practiced by bespectacled corporate drones and the sorts of people who once excelled at competitively reciting the digits of Pi. Traders did not practice risk management, they practiced risk taking. They also generally worked in a pit, settled disputes with their fists, and had very little use for more than two decimal places. This all changed in 1997 with the publication of Nassim Taleb’s groundbreaking text, Dynamic Hedging. Dynamic Hedging offered the first glimpse of Taleb’s pragmatic approach to trading risk management, in which market-facing practitioners must understand the limitations and idiosyncratic nuances of the tools and techniques they deploy, lest they be destroyed by ignorance or misplaced confidence. Be warned, Taleb asks a lot of his reader, presenting high-level information at great velocity, frequently with little preamble. Prospective readers should consider a warm up lap through Hull’s Options, Futures and Other Derivatives to refresh their understanding of the basics of option theory and derivative math before attempting Dynamic Hedging.
9. Reminiscences of a Stock Operator by Edwin Lefèvre
Every list of the best trading books must contain Edwin Lefèvre’s Reminiscences of a Stock Operator. Reminiscences is a fictional work that somehow manages to incorporate literally every significant trading principle into the boom and bust cycles of the protagonist’s story arc, all without feeling contrived or sounding like textbook. Reminiscences of a Stock Operator was published in 1923, and it is impossible to fully appreciate how revolutionary it must have been in its time. One caution for prospective readers, since as a work of fiction it is not as heavy-handedly pedagogical as a pure textbook, it is possible to inadvertently skim over valuable information. Take the time to give Reminiscences of a Stock Operator your full attention, it is well worth it.
10. Market Wizards: Interviews with Top Traders by Jack D. Schwager
11. The New Market Wizards: Conversations with America’s Top Traders by Jack D. Schwager
Jack Schwager’s Market Wizards and New Market Wizards books are a series of interviews the author conducted with a group of elite commodity, foreign exchange and bond traders. In my opinion, they are critical books for novice traders to read, preferably early in their career. Neophyte traders are frequently told that there is a “correct” way to approach a particular market. This is not true. Every trader must develop a style that compliments (and leverages) their unique individual strengths, and Schwager’s books are the best possible proof of this theorem. All manner of personalities and trading styles are on display, the common denominator being that each interview subject has developed a method of observing and interacting with the market that makes sense to them. The reader is free to compare and contrast different methodologies, a particularly useful exercise for young traders who are still evolving their own approach to the market. There is a tremendous amount of practical information on offer, and the interviews with Bill Lipschutz, Stanley Druckenmiller, Paul Tudor Jones, and James Rodgers are well worth the price of admission.
12. Charlie D. The Story of the Legendary Bond Trader by William D. Falloon
Fallon’s Charlie D is a somewhat obscure biography of bond trader Charlie DiFrancesca, who in the late 1980s was the largest independent trader in the Treasury pits (a mantle later passed to Tom Baldwin, one of the interview subjects in Schwager’s Market Wizards). Charlie D’s life story is interesting, to be sure, but the real value in the book lies in Fallon’s transcription of a videotaped presentation DiFrancesca gave in 1989 to members of the Chicago Board of Trade. It is possibly the most valuable 30 pages I have ever read on the technique of trading. Though Charlie D is describing a somewhat dated, very pit-centric method of interacting with other traders, the basic concepts of evaluating a market, acting with decisive intent when transacting, and learning to be disciplined when taking profits and losses are as critical now as they were then.
13. Every Hand Revealed by Gus Hansen
I argue in Trader Construction Kit that playing medium to high-stakes no-limit poker is the best possible method of learning to take trading risk, short of actually sitting on a desk. Gus Hansen’s Every Hand Revealed presents a unique opportunity to look over the shoulder of a world-class poker player as he plays through five days of a major tournament. Hansen took detailed notes on each of the 329 hands he participated in during the tournament, including his risk/reward assessment, strategy, mid-hand decisions, and the ultimate profit or loss. The reader is able to follow along as Hansen works through 329 decisions under uncertainty, and in so doing provides a unique perspective on the cumulative effects and path dependence of trading/risk management decisions. It is fascinating to observe how Hansen’s decision calculus on the 190th hand (for example) is impacted by the considerations immediately relevant to the 190th risk/reward scenario and the cumulative information gained and psychological wear & tear accrued from hands 1 through 189. This is something not generally touched on in theoretical literature, but is very much a part of trading in the real world. Trading decisions are not isolated events that occur in a pristine intellectual vacuum, and every trader must find a constructive way to manage the ongoing process of operating in the market.
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