Another interesting article from MSNBC about "super margin". Comments would be appreciated.
Moby.
OPINION
By Christopher Byron
MSNBC CONTRIBUTOR
Jan. 21 — 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?
ONE 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 “super-margin” day traders — 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.
Super-margin traders are the gunslingers who show up for Wall Street's 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.
The 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 — the darling stocks of the gunslingers.
The uncertainty arises because the brokerage firms that cater to the super-margin trade don't 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.
A FEW HUNDRED — OR MORE?
No 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 “proprietary traders”) now in the market. In fact, the true number is almost certainly several times that amount. Just one firm — Schonfeld Securities Inc. of New York — 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.
In December, Schonfeld Securities alone accounted for 4 percent of the total month's 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 company's traders alone account for 6 percent to 8 percent of total New York Stock Exchange volume on any given day. “We'll start you off with $1 million and see how it goes,” says the recruiter. “Our best traders are doing $15 million a day.”
Schonfeld 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. Since then a number of other firms have followed in its footsteps. There's Harbor Securities, which offers 10-to-1 margin on
minimum trader accounts of $25,000. And there's 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 “over 300
traders” 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.
DEMAND FOR GUNSLINGERS
With 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 Securities' Web site says that if you don't know how to trade,
the firm will train you.
Industry spokesman Bill Lauderback of the Electronic Trader's 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 firm's own capital and (c) possess valid broker's licenses from the National Association of Securities Dealers.
By meeting these requirements, the firms become trading operations no different from the trading desks at almost any well-known Wall Street firm.
On 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. Interviews with several traders at super-margin firms revealed that none possessed valid NASD broker's licenses. Nor is it clear that traders are hired by the firms as actual employees instead of simply brought in as independent contractors.
Schonfeld 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 “members.” Compensation is not by salary but strictly as a share of the profits generated by the
trader's 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 — another badge of independent contractor status.
SETTING OFF ALARMS
Super-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 — at least when the market reflects a continuing upward bias in prices. That's 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 trader's position the instant his equity is gone — in effect vaporizing the account before it begins devouring the firm's own margin capital. This 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 — investors who are betting that the shares will “gap-up” at the next morning's opening. (If stocks “gap-up” it means they open a point higher than they closed; conversely, if they “gap-down,” they open a point lower.)
This 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, Amazon's shares have opened “gap-down” twice (Jan. 13 and 20), losing 43 percent of their value in the process.
It is this down-opening gap that is inevitably aggravated by super-margined day traders positions in an end-of-day market where buyers are becoming scarce.
DOWNWARD PROCESSION
From 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.
Whether this downward pressure represents an about-turn in market psychology regarding these shares remains to be seen, but there's 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.
Whatever happens with eBay, there's 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 “gap-up” or “gap-down” from the previous day's close. It will give you a good clue as to what sort of sentiment is taking root in the shares. |
