“I applaud your web site and all of your efforts to provide a variety of comprehensive information for all types of traders. As a member of a fixed income trade support team, I always try to analyze our traders’ decisions and strategies, while keeping a watchful eye on market movements. I have enjoyed many of your articles about individual traders, advice, and strategies. I also found your article regarding Goldman Sachs Research especially true to reality. I agree one hundred percent with your analysis and opinion of how meaningless this research actually is. Any securities research (originating from one of the larger dealers on the street) is most likely rife with conflicts of interest. The most ironic and entertaining aspect of all this supposedly astute and insightful research is that (as you pointed out) these dealers do not even incorporate their research into their trading strategies!” — Web Visitor at Major Investment Bank

What the Insider Is Confirming

The observation from someone working on a fixed income trade support team at a major investment bank carries specific weight. This is not a retail investor speculating about whether Wall Street research is honest. This is someone inside the machine who has access to what the firm’s traders actually do, and who is observing the gap between the published research and the actual trading decisions.

The gap the insider describes is the most damning structural fact about Wall Street sell-side research. The analysts who write buy recommendations are employed in the research division. The traders who deploy the firm’s capital are employed in the trading division. These are not the same people. The traders’ compensation depends on their trading performance, which gives them every incentive to use the best available information rather than the publicly published research. If the research were genuinely valuable as a trading signal, the proprietary trading desks would use it. The traders’ revealed preference is the honest assessment of the research’s value.

The conflict of interest problem compounds this. Investment bank research divisions exist to support the investment banking business, which generates revenue from IPOs, secondary offerings, and corporate advisory services. Analysts who publish negative research on companies that are investment banking clients create problems for the banking relationship. The structural incentive is to publish research that is either positive or neutral on companies where the firm has or wants investment banking relationships. This is documented and well-known. The insider’s confirmation that it is “most likely rife with conflicts of interest” for large dealers is an understatement.

The practical implication for individual investors is the one the insider emphasizes: if the people with the best access to this research, the firm’s own traders, do not use it to make their own trading decisions, there is no rational basis for retail investors to use it to make theirs. The research is produced to serve the investment banking relationship and to satisfy the retail distribution channel’s demand for content. It is not produced because it generates trading profits for those who act on it. If it were, the traders would be acting on it.

Trend following’s rejection of analyst research is not contrarian posturing. It is the rational response to the documented structural reality that the insider confirms. Price is the signal. The analyst’s published opinion about where price should be is not a signal. It is content produced for a different purpose.

Frequently Asked Questions

Why don’t investment bank traders use their own firm’s research?

Because the research is produced for client distribution and to support investment banking relationships, not to generate trading profits. The traders whose compensation depends on their actual trading performance use the information they believe will produce results, not the published research that serves other purposes. The gap between what analysts publish and what traders do is the honest assessment of the research’s trading value.

What are the conflicts of interest in sell-side research?

Investment bank research divisions serve the investment banking business, which generates revenue from corporate clients. Analysts who publish negative research on existing or potential investment banking clients create relationship problems. The structural incentive is to publish positive or neutral research on firms where the bank has banking relationships. This produces systematic optimism bias in published recommendations that is well-documented in academic research on analyst behavior.

Why does trend following ignore analyst research?

Because price already reflects the aggregate of all research, including non-public analysis by institutional participants with better information than published sell-side reports. The systematic trend follower who reads price directly is reading the market’s aggregate assessment of all available information, including whatever was correct in the analyst’s research. Acting on the analyst’s published opinion rather than on price adds a layer of interpretation that introduces bias without adding information.

Trend Following Systems
Want to learn more and start trading trend following systems? Start here.