Jan. 21 ó Anyone watching the behavior of Internet stocks during the
last hour of trading on Wednesday would have noticed something unusual:
they all seemed to fall apart at once. Yahoo! Inc. dropped from $308 to
$288, Amazon.com fell from $119 to $113, and eBay Inc. fell from $218 to
$213. Plenty of others behaved the same. The question is, Why?
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Ý Ý Ý ÝONE EASY EXPLANATION would be that the market as a whole turned
weak in the last hour of trading, so Internet stocks fell along with
everything else. But another and murkier force may be at work: the
growing importance of so-called ìsuper-marginî day traders ó a rapidly
increasing presence in the market that not even the Securities &
Exchange Commission or the National Association of Securities Dealers
seem to know much about.
Ý Ý Ý ÝSuper-margin traders are the gunslingers who show up for Wall
Streetís daily shootout armed not with the BB guns of 50 percent margin
credit packed by normal retail investors, but with the 50-caliber
machine guns of 10-to-1 margin granted under federal rules to brokerage
firms themselves. Such leverage allows the super-margin day traders to
plunk down as little as $25,000 into an account and instantly begin
buying and selling as much as $250,000 worth of stocks. Many
super-margin firms grant margins even higher than that.
Ý Ý Ý ÝThe catch is, the gunslingers have to sell out their portfolios
by 4 p.m. ET each day or risk losing their $25,000, which in turn puts a
daily, late-afternoon cloud of uncertainty over the whole market, and in
particular the Internet sector ó the darling stocks of the gunslingers.
Ý Ý Ý ÝThe uncertainty arises because the brokerage firms that cater to
the super-margin trade donít want their capital left at risk overnight.
Thus, they typically require the traders to liquidate their positions
before the close of business each day. This means that when 4 p.m.
approaches and the gunslingers begin rolling out of their positions, a
mild decline in prices can quickly escalate as an avalanche of stock,
controlled by a relative handful of traders, gets dumped onto the
market.
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A FEW HUNDRED ó OR MORE?
Ý Ý Ý ÝNo one really knows how many super-margined day-traders are in
the game, but the number is clearly growing. William Lauderback, the
head of a Texas trade group representing the day trading industry, says
he estimates that there are less than 500 such people (the industry term
for them is ìproprietary tradersî) now in the market.
Ý Ý Ý ÝIn fact, the true number is almost certainly several times that
amount. Just one firm ó Schonfeld Securities Inc. of New York ó claims
to have 400 to 500 such traders in the market all by itself. And thanks
to super-margin, each of these traders has buying-and-selling clout
equal to 10 normal day traders. Yahoo! Inc. (YHOO) pricechange$265.00
-22.188 Amazon.com, Inc. (AMZN) pricechange$106.00-7.000 eBay Inc.
(EBAY) pricechange$181.75-32.000 MarketWatch.com, Inc. (MKTW) price
change$75.00+2.500 Data: Microsoft Investor and S&P Comstock 20
min.delay
Ý Ý Ý ÝIn December, Schonfeld Securities alone accounted for 4 percent
of the total monthís trading volume in Yahoo, 3 percent of the volume in
Amazon.com and Intel, and 2 percent of the volume in Microsoft, Lycos
and Mindspring. A Schonfeld official designated to field inquiries from
would-be gunslingers claims the companyís traders alone account for 6
percent to 8 percent of total New York Stock Exchange volume on any
given day. ìWeíll start you off with $1 million and see how it goes,î
says the recruiter. ìOur best traders are doing $15 million a day.î
Ý Ý Ý ÝSchonfeld Securities is the grandfather of the field, having been
established in Great Neck, N.Y., back in 1988. The company has since
opened up trading offices in Jericho, N.Y., Manhattan, Chicago, Boca
Raton, Fla., and most recently, in Purchase, N.Y.
Ý Ý Ý ÝSince then a number of other firms have followed in its
footsteps. Thereís Harbor Securities, which offers 10-to-1 margin on
minimum trader accounts of $25,000. And thereís Bright Trading Inc.,
founded in 1992, with offices now in New York, Chicago and 19 other
cities. Or what about On-Site Trading, which has offices in New York,
New Jersey, Colorado, Florida and Maryland, and claims to have ìover 300
tradersî in the market. Or Lieber & Weissman Securities LLC, of New York
City and Denver, which also offers a 10-to-1 margin for day trading.
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DEMAND FOR GUNSLINGERS
Ý Ý Ý ÝWith the market swelling into a bubble of seemingly historic
proportions, especially for Internet stocks, demand for day traders to
staff the desks at these gunslinging firms seems insatiable. A number of
super-margin firms are now recruiting for traders via Web sites on the
Internet. Bright Securitiesí Web site says that if you donít know how to
trade, the firm will train you.
Ý Ý Ý ÝIndustry spokesman Bill Lauderback of the Electronic Traderís
Association says that under federal regulations, super-margin credit can
be extended only to traders who (a) are hired by the gunslinging firms
as actual employees, (b) trade only the firmís own capital and (c)
possess valid brokerís licenses from the National Association of
Securities Dealers.
Ý Ý Ý ÝBy meeting these requirements, the firms become trading
operations no different from the trading desks at almost any well-known
Wall Street firm.
Ý Ý Ý ÝOn the other hand, the business is growing so rapidly, one gets
the clear impression that a lot of corner-cutting is going on in hiring
practices.
Ý Ý Ý ÝInterviews with several traders at super-margin firms revealed
that none possessed valid NASD brokerís licenses. Nor is it clear that
traders are hired by the firms as actual employees instead of simply
brought in as independent contractors.
Ý Ý Ý ÝSchonfeld Securities says its traders are all fully licensed and
that they work for the firm as full employees. But with other firms the
situation is less clear. An application to day trade on 10-to-1
super-margin at Harbor Securities describes the traders not as employees
but, more vaguely, as ìmembers.î Compensation is not by salary but
strictly as a share of the profits generated by the traderís own
trading. Traders at Harbor can also trade from the comfort of their own
homes, over the Internet, setting their own hours and work schedules ó
another badge of independent contractor status.
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SETTING OFF ALARMS
Ý Ý Ý ÝSuper-margin firms are eager to hire anyone they can because, the
way the business works, the more trading that takes place, the more
commission dollars are generated for the firm. Meanwhile, the firms
themselves run very little risk with the margin they extend to their
traders ó at least when the market reflects a continuing upward bias in
prices.
Ý Ý Ý ÝThatís because, even at 10-to-1 margin, a day trader still has a
10-percent equity cushion in any stock he holds on credit from the firm.
And the firms all have trip-wires in their software to ring alarm bells
when trader accounts are getting into trouble and that equity cushion is
beginning to disappear. This enables the firm to liquidate a traderís
position the instant his equity is gone ó in effect vaporizing the
account before it begins devouring the firmís own margin capital.
Ý Ý Ý ÝThis sort of hair-trigger risk is less threatening to traders
when the pricing bias in volatile stocks is upward. An end-of-day
liquidation of day trader positions is simply likely to move the shares
into the open arms of retail buyers willing to hold the shares overnight
ó investors who are betting that the shares will ìgap-upî at the next
morningís opening. (If stocks ìgap-upî it means they open a point higher
than they closed; conversely, if they ìgap-down,î they open a point
lower.)
Ý Ý Ý ÝThis has happened day after day in Internet stocks since last
summer, as shares like those of Amazon.com have soared from less than
$20 to a split-adjusted intraday high of nearly $200 on Jan. 8. But in
the seven trading days since then, Amazonís shares have opened
ìgap-downî twice (Jan. 13 and 20), losing 43 percent of their value in
the process.
Ý Ý Ý ÝIt is this down-opening gap that is inevitably aggravated by
super-margined day traders trying to liquidate positions in an
end-of-day market where buyers are becoming scarce.
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DOWNWARD PROCESSION
Ý Ý Ý ÝFrom its opening day high of $130, MarketWatch.com has fallen by
nearly 45 percent in just three trading sessions. Data Broadcasting
Corp. is down by 68 percent from its intraday high of more than $50 in
just the last six sessions. Yahoo is down by 35 percent during the same
period.
Ý Ý Ý ÝWhether this downward pressure represents an about-turn in market
psychology regarding these shares remains to be seen, but thereís plenty
of downside pressure possible in the coming days. One big negative on
the sector: More than 20 million shares of eBay Inc., the Web auction
site, that will become available for sale by company insiders as soon as
this Friday, Jan. 22. This will increase the current float by possibly
as much as 700 percent, eliminating all scarcity value in the stock and
creating possibly severe downward pressure on the price, which has
fallen by nearly 30 percent in the last two weeks anyway.
Ý Ý Ý ÝWhatever happens with eBay, thereís an easy way to tell which way
the wind is blowing for any of these super-margined gunslinger stocks.
Just check the prices of the shares every morning and see if they open
ìgap-upî or ìgap-downî from the previous dayís close. It will give you a
good clue as to what sort of sentiment is taking root in the shares.
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