Free Trading Isn't What You Think It Is (Wall Street CEO Explains)

0:07So Daniel, I'm glad to have you on today because the stock market this year is bananas. Like the SpaceX momentum was insane. I've never seen people talking about something. And then you have OpenAI and you have Anthropic. I mean, there's just so much craziness in the market this year. Before we get into all trading, you planned on law school and then you answered a newspaper ad. It's even funnier than that. It wasn't even a paid for newspaper. It was one of those free newspapers they give you on the subway, you know, like the metro newspaper they hand you when you take the subway. And I just assumed I was going to go to law school and I didn't get into the schools I wanted to go to.

0:50And I hadn't really done any internships to get any real jobs because I was working for the university for the four years I was there. and I didn't really know what I was going to do. And then I answered an ad to become a stock trader in literally a free newspaper that I was reading on the subway when I had no idea what I was going to do. You never know where ideas are going to come up. And I think we can all agree that whatever you think you're going to go to school for is probably not going to be what you end up doing. Back when all the mortgage chaos happened, I worked for a mortgage company for like three weeks, and then that company just fell apart, and I never went back.

1:22for you, you also had a story where the original firm also fell apart. So the original firm, in its early days, was one of the largest trading firms on Wall Street, probably around the world. It was all entirely human-driven, which were mostly human-driven today, but it was a very large firm. And it was run by a couple of real entrepreneurs whose backgrounds were in tech and porn and other different businesses and really didn't really know how to run the trading firm. And they were doing extremely well financially, making a lot of money. And they just really didn't enforce any rules on the traders or really had any supervision of what these traders were doing.

2:05And you can't really let 4 ,000 traders trade all over the New York Stock Exchange with no rules. So they ended up getting in quite a bit of trouble. And I had the opportunity to take the pieces I wanted of the business and the good pieces and and build the business I have now. When you looked at, these are all the things I don't want to do. And these are all the things I want to do when I'm starting my own business. How do you look at the transition between the employee to now owner? Well, I, in the later time as employee, I was effectively running the trading business once it had its problems.

2:39And I was sort of brought in to clean up those problems. It was very obvious that those problems could not really be cleaned up. And it was kind of easy to figure out. I actually got kind of lucky in a weird way where the regulators were telling the trading from all the bad things they were doing. And I could just sort of look at those things that they were telling us not to do. And I said, OK, I'll just I'll take the pieces of the business, but don't do that. So they literally handed me the playbook on what were the good parts to take. What lessons did you learn from management that was either not great or great?

3:10Because I feel like I've learned so many things working for different jobs. and I learned from my managers of all the things to do and all the things not to do. Yeah, I mean, I think the thing that I took that was very, very positive was that the people who founded the business had an unbelievable work ethic and were very, very creative and really just amazing at growing businesses and building them up. What they didn't really do was kind of read the rule book. Like I think if they were in a different industry, it would have been different. but in the stock market world, it's very highly regulated.

3:43And you have to sort of take regulation first. So the firm I have now is built on a regulation first platform. We actually have probably one of the best compliance platforms on the planet. Even the regulators have looked over ours and think it's pretty unbelievable. We built it ourselves. I just realized if you want to be in this industry and you want to have a good reputation and you don't effectively want to go to jail, you've got to do the right thing. And you're in a regulated industry, you've got to do the right thing and they just they just didn't have a focus on it uh they were focused on grow grow grow build build build and it caught up to them everyone's talking now around human versus ai which is a better trader i was talking with a friend of mine and he was saying that no matter what they've tried humans to them seem to be better i mean i i tend to agree look i think if you're trading at a large scale and you're using computers to trade uh some of the large firms like Jane Street, Citadel, HRT, these big, big, big large trading firms, they obviously use computers to do the trading, to execute the trades and to run the models.

4:47But there's always a human being that sits on top of it that has some judgment as to what's going on. And I think, as we talked about before with the regulation, I think one of the biggest challenges the industry is going to face when you move into this AI stuff is, let's just say the computer does something wrong, or let's just say the model does something wrong. You can't just go to the regulator and say, oh, sorry, my AI model that I put into this computer, it's its fault, right? There has to be accountability. Somebody has to stand up and say, like, I'm taking responsibility for what's going on here.

5:15And I think there will always be somebody taking that responsibility. And you can ever pull the human out of the trading. Is there any catch that most people don't see when it comes to funded trader programs? Yeah. So funded trader programs, we touch on this in the book. It's, I mean, it's just very simple to say they're just a scam, right? You only make money when the trader loses. So the way they work is you go and collect a fee. Let's say you collect$500 or $2 ,500 from somebody. You give them like an audition, and then they go audition. If they pass the quiz, the test, then they're given an account.

5:51The account is actually given to trade what are called CFDs, not even stocks. So most people don't even realize they're not trading stocks. And then the model is that they just want you to lose. So the whole model is, can I collect more$2 ,500 fees than I pay out to the people that are actually profitable? And then they put all kinds of hoops on how you can get paid and whatnot. But then the advertisements are all just from the very select few that have gone through it. But the numbers are crazy. And what we did is we learned about it because I went and just signed up for one of these things. And I figured out a way to sort of game it.

6:23So I beat it. So I got one of the funded accounts and I went and looked at how the funded accounts work. And it's just, they're huge. They're completely unregulated in the U.S. and they're businesses that are just based on people losing. Like, so it's just, it's one of them came to visit me and said, we want all of your bad traders. Can you send all your bad traders to us? And I said, it's crazy. If anyone wants anything bad, unless it's like a trash company, then, you know, it's probably not good. I know a lot of U.S. trading now is happening off the exchange. I don't think a lot of ordinary people know about this.

6:58Why should they care? This is a hotly contested debate. This actually came out quite heavily when the meme stock craze happened. There was a lot of discussion about it. But I think if you went to the streets and you pulled 10 people that walked by and asked them when they're broke or when they go by in their 401ks that they go buy Ford or SpaceX even. You assume that your broker is going and he's getting you SpaceX from the NASDAQ or he's getting you Ford from the New York Stock Exchange. When most people don't realize that over 50 % of all stock transactions, you are just going to a market making firm like Citadel and they are just giving you the shares off the exchange.

7:41and why people need to be aware of this is you look at robin hood you look at all of these big trading platforms td ameritrade we have this advent of what we call free trading and everybody's so excited they can go trade for free now and it's easier to get access to the stock market the problem really is nothing in life is free so if if you're getting something for free and in fact if robin hood is getting paid to send your order to citadel and not the new york stock exchange I don't know how anybody thinks that this is a positive thing. The consumer has become the product. And I think that, you know, I use this analogy.

8:20If you were going to go sell a painting and you went to Christie's to sell the painting, do you think you'd get the best price if you only had one person you would sell it to? Or if you had thousands of people watching the auction? I think you'd want thousands of people watching the auction. They've led us to believe that the one person can be more efficient, but they just can't be. How do you think we got to this point? We got to the point, there was a few rule changes a long time ago, in 2005, that opened the floodgates to this kind of automated trading. And then in reality, you have a few firms that make up a huge percentage of the market these days.

8:55I mean, some of these firms are reporting revenues of$16 billion a quarter. So they have such scale. I think the statistic is that Citadel sits on one side of like 25 % of all stock transactions in the US. That's an unbelievable amount of information that they're getting, and they're paying for that information to these brokers to get it. And they've convinced people that this is a good thing. In fact, in Washington, the hearings that they had over the mean stock stuff, the head of Citadel even said that he You could cut the way stocks trade by half a penny, so cut it in half, and they'd be fine with it.

9:34And just shows you that's where the profit comes from. So they're literally saying, yeah, cut our profits in half and we'll still be fine. Some people would say that the Robin Hoods are bringing in a new generation of people into trading, but it sounds like there's also a trade-off, essentially, when you're doing these platforms. What worries you most about turning trading basically into a video game? So this is a topic we talk about a lot. And this is the one I think it's getting even worse than what you're saying, because you're bringing people in a new generation. I agree. They have. And I think COVID brought a new generation in, new access to the markets, and they're gamifying the way you trade.

10:11But if you take a look at things now, they've made it so that there's no minimums to what you can buy. It used to have to be you have to buy 100 shares or you have to buy one share. Now you can buy$5 of any company if you want to buy it, which is fine. But I think the biggest issue is what these accounts are really being used for is speculation and not investing. So you take a look at the generation before us and they would go buy the S &P 500 or Berkshire Hathaway or companies that paid bonds, bank stocks. You would buy it in your 401k every year, you'd add a little bit more. And then when you retire, you'd have all these stocks sitting there, these blue chip companies.

10:47Now, everything is just speculation. It's just trading. I mean, the stocks are trading at multiples that don't make any sense and people are clamoring to get in them. You now have the advent of prediction markets, which is insanity to me, right? So we're now allowing you through your broker to take money that you would put in for your retirement. Instead, you can go and predict the outcome of the weather. And these are binary bets that if they had... So in the UK, on these speculative accounts, you have to post on the website the winning percentage of accounts that you have. Because the UK regulators realize this is too speculative.

11:24I promise you, if you posted in the US on these accounts what the numbers were, you would see the vast majority of these accounts are losing money. In fact, one of the stats I heard is that 2 % of the accounts in prediction markets are receiving 90 % of the profits. Wow. I didn't know that from the outside looking in. Yeah. You think everything is gravy. Everything seems nice. It's changing the game. I'm always obviously worried about addictions and you know, anything that feels like you can hit the lottery creates the instant addiction. You wrote this book though, real trading right here. Why did you write a book?

12:01Book is a painstaking process. I wrote a book too. Two years of my life went into that book. But real trading, why is this book so needed right now? Well, two years of my life went into that book, so I know exactly what you're feeling. Look, one of the things we talked about is, so I have multiple businesses that I run. We have a YouTube channel and then a TV show that's successful. We help educate a lot of people, retail traders on trading. I run a proprietary trading firm. We have an investment firm. We do a bunch of different things. And what I realized, if you take a look and go to Amazon or any of the bookstores and you look at how many people really write about the stock market and write about trading, it's not a lot.

12:40Because the main issue is that most of the people working in the industry work for a bank, which won't allow them to publish a book. And then you see books written by some of the biggest hedge fund managers because they control their own destiny. But a lot of them don't even want to talk about things because they don't really want to give away their secret sauce. so I thought it was time where there are so many challenges there's so many people talking about computerized trading there's so many people talking about um uh off-market trading and I figure we we could talk to a lot of those topics and get them out there and and timing really well I thought this thing was going to be done a year ago so it took a lot longer there's some current events in there that we needed to see if they settled and everything worked out well but it was really just to sort of get some of these misnomers about the stock market out into the public and see a people who are receptive to.

13:27You know what I've come to realize is wealthy people understand the game. If you're not wealthy, you don't even know about the opportunities that exist. Like before SpaceX, I didn't even know that buying private shares or pre-IPO shares was even a thing. This is the first time I ever even heard about it. What are some of the things that you're seeing in trading that the average person would not know? What are the secrets that wealthy people know? Well, there's a couple of interesting secrets. And it's funny, it's a regulatory rule in Canada. I don't know the exact rule in the US, but in Canada, at least, if you wanted to buy pre-IPO shares in a company, so there are a couple of exchanges you can go do that with, you by definition have to be wealthy to do it.

14:12There's a minimum net worth requirement that you be considered a sophisticated investor to be able to go buy this. So the average person doesn't even have a chance. So there's the sophistication rule in North America. It in itself creates a barrier where only the wealthy can access certain things. So if you wanted to go invest in a hedge fund, for instance, you cannot go invest in a hedge fund that doesn't have listed shares on an exchange. So if you want to go invest in some of the biggest hedge funds in the world that are returning, outperforming the general stock market, you by definition have to be wealthy to do it.

14:50You have to show that you have, I think it's net liquid assets of over$2 million are the rules. So it's not even that people are trying to keep this a secret, it's that if you're not wealthy, you can't even get into a lot of these things. And then they access, a lot of the big funds, they don't really want to go take money,$1 ,000 from somebody,$10 ,000 from somebody. They want checks in the millions of dollars or hundreds of thousands of millions of So by definition, the less wealthy people are priced out. It's just kind of how the system works. More risk, more reward. And the concept is if they don't consider you're sophisticated enough, you can't access that risk.

15:30And the definition of sophistication is net worth. Do you think with technology changes, new platforms coming on, do you think the access will get easier or harder? Easier. I think what you're going to see is you're seeing that access becoming easier. You even hear of the Robin Hoods of the world are going to give access to private companies, to people, and they're going to give... The access has been getting easier and easier over time. I think I said before, you used to have to buy 100 shares of a stock when you're buying or you have to buy round lots of a stock. They've now made it so you can go buy$5 of a company.

16:03You can go buy... If you were trading in the dot-com era, you had minimum trade sizes and you had fees of $50, a buy,$50 to sell. everything they're doing is giving people more access now the question i ask is is this good for society as a whole because what we're seeing is people are not using that access to do the right thing they're just using that access to speculate and speculate on a short-term basis i use an analogy always um you know if you woke up one day and you had like a big growth on your arm and you come downstairs to your kitchen and you google hey how do i cut this thing out of my arm and you open the drawer, you pull a knife at them, you've got Google, you've got the knife, and you've got the thing, you wouldn't go cut this thing off your arm.

16:49You would probably go see a doctor. And I think the problem is that with all the tools that we're giving retail investors, they're forgetting that they're trading against people that went to school for a long time to learn about this, that have access to different information that they have, and licenses to ensure that they don't do stupid things. But one of the analogies is if my firm wants to go trade options tomorrow as an institutional client. We have to fill up paperwork. We have to show we're proficient. We have to show our brokers that we understand things. We have to have the right risk controls.

17:20If you're an 18-year-old with a Robinhood account, you can be trading options by the end of the day if you just click on the contract. It's kind of crazy. The access is getting easier, but I'm not sure if that's a good thing. I think there's a lack of education. There's a lack of knowledge to the person. Just because you can do something doesn't mean you should be just buying fractional shares all over the place without having any understanding. And I imagine that person probably just asks ChatGPT, which we know isn't going to give the correct information like someone who's had it. I've heard that you've had only 12 losing days in 14 plus years.

17:58Yeah. How's that possible? So it's possible because we have a very, very strong risk system. We have thousands of people working for us on a daily basis that are trading for us. And there's a concept called the law of large numbers. When we have, let's just say we have 10 people trading a stock, okay? There's only three things that can happen when we trade a stock. It goes in your direction, it goes against your direction, or it goes nowhere. Our risk systems and the discipline that we teach our traders, we limit when it's going against you the wrong way. Most people's instinct is to buy more or average down or panic.

18:36Our system literally, if you were in a bad trade and it goes beyond the risk that we believe you should have, a big clock comes up and tells you get out of the trade or we're getting you out of the trade. And then if the clock expires, our system just wipes them out of the trade. And I think that we have built in discipline tools into our system. So we leave the upside unlimited and the downside is highly limited. In fact, we have a feature in our system, I don't know any other company that does this, where we will shut a trader off even as a function from their highest point in the day. We call it loss from top.

19:08So if the trader had made a million dollars, but their allowable loss from top is 10 ,000, we will cut them off at$990 ,000. They'll scream at us. They'll yell at us. They'll say, why are you cutting me off? I have all this extra profit. But it's because what you'll see is people get into spirals and they'll lose. So the reason we don't lose that much is we're trading for small amounts and we have lots of people doing it. Does AI eventually replace a human trader or make them more valuable? And what is your one message to somebody who is tempted by those flashy apps right now? So I believe when I took when I when I launched my version of the company and we went out, I was told by many people that the company will eventually get replaced by computers.

19:53You don't all these humans. A good example would be SpaceX, the IPO. So if you want to build an algorithm that you want to, AI wants to come in and trade SpaceX, the way that these things work, it's called machine learning. You take data, you run it in a system, and it learns from the past to predict the future. Well, how do you predict the future when there's no past? So when the company goes public the first day, what information are you using to really go around and trade it? So human being and human judgment comes into many different parts of the stock market on a daily basis. When news comes up that fundamentally changes a company or you have mergers and acquisitions, there are periods of time where there's just not enough data out there for a computer to make the proper decisions.

20:35In fact, the computers generally shut off in those opportunities and the humans really take over. I think the stock market is an evolving thing and it's always going to do it. It's always going to change and you're always going to need human insight. I think the tools will make humans even better at it, but there's always somebody at the top that's making these decisions. When it comes to the apps, I just think, I've said this before, we really need to ask ourselves, what is the goal here? Should an app be encouraging you to buy, sell, buy, sell, buy, sell all day long with absolutely no education and burning the money that you're supposed to be saving for retirement?

21:12I don't think that's really the goal. And I think you have to understand if you're sitting there and you're going to go buy for your 401k or buy long term, those apps don't encourage that, right? Because they make their money the more you transact and they're literally encouraging you to sell. I mean, money flies in the air when you make a trade. It's just they're designed for turnover. And I just don't know if that's the right thing. Compound interest is you earn it by buying and holding things, not by turning it over all day long. Real trading. I love the book. I've been reading the book, but trading has always been something in my life.

21:47And there's so much, like you're saying, the technology changes every five seconds, but it still feels we really, really need a human if you want to maximize. But I hope everyone gets the book and everyone checks out your company. And thank you so much for joining us today. I really appreciate it. Thanks for having me. Have a good day.