I mean, let's say the exchange rule is you can buy a stock on a 50% margin, how is it possible for the leverage to be higher than that? I've read some messages here where people said 40:1 or whatever. What does that mean exactly? (I've read books on trading, I'm just not familiar with that.)
How do prop firms leverage your trades?
- Thread starter coolpurplefan
- Start date
Our traders trade in one big Bright Trading account, funded with our family money. As exchange members we're able to use 6.67 times that equity for all the traders to trade with. We don't need to use the traders money for this purpose, and yet we have 400-500 traders using what they need. We, with the help of Goldman Sachs, monitor each traders risk on a real time basis of course. The 50% margin is for retail traders.
(There's a lot more to the whole thing, but those are the basics)
Don
Say you have 20 traders each put up 50k deposits (for simplicity sake). That gives you 1MM on deposit, 4MM buying power using intraday margin rules.
Now, you give each trader 20:1 leverage on their 50k, that"s 1MM buying power (BP) each. Times 20 traders, isn't that 20MM BP?
Well, yes and no. Each trader has their own limits but the setup is that it would be extremely rare that all traders would use all of their equity at the same time, thus overeaching the main accounts trading limits. Plus, you have trades that would offset each other having no effect on the main account margins. You may be long 1000 shares of Citi, but another guy is short the same amt, thus crossiing out the trades (for margin purposes on the main account)
Generally a prop owner will have to put up some of his own money to protect his group in the event that this marging of the main account is breached. There are groups out there that don't back their group's trading with any of their own funds, and these are usually the horror stories you keep hearing about.
* this is a generalization about non-licensed prop firms since the main account that a prop uses is nothing more than a retail trading account which uses money management features to control each individual trader's accounts.
Now, you give each trader 20:1 leverage on their 50k, that"s 1MM buying power (BP) each. Times 20 traders, isn't that 20MM BP?
Well, yes and no. Each trader has their own limits but the setup is that it would be extremely rare that all traders would use all of their equity at the same time, thus overeaching the main accounts trading limits. Plus, you have trades that would offset each other having no effect on the main account margins. You may be long 1000 shares of Citi, but another guy is short the same amt, thus crossiing out the trades (for margin purposes on the main account)
Generally a prop owner will have to put up some of his own money to protect his group in the event that this marging of the main account is breached. There are groups out there that don't back their group's trading with any of their own funds, and these are usually the horror stories you keep hearing about.
* this is a generalization about non-licensed prop firms since the main account that a prop uses is nothing more than a retail trading account which uses money management features to control each individual trader's accounts.
A couple of points to consider:
2 years ago FASB150 Financial Accounting Standards Board changed all the rules as far as "pooling" traders money. It used to be that the firm could count the trader money as an asset...now they have to count the trader money as a liability (as banks do). That eliminated a huge number of trading firms.
Regarding the "long short" above: We lobbied hard for, and still maintain, what is called aggregation among our traders. If you have the Firm account treated as one account for all purposes, you would have a real mess. For example, if you bought 1000 GE, and the Firm was net short GE, you would have to submit a short sell to close your position (which is a regulatory violation). Our traders are treated individually for long short purposes.
Don
When operating a "pooled" group you can monitor exposure (buy/sell) for the whole group, and most often this wont be more than a couple of millions net the one way or the other. If there for some reasons are days with huge net exposure you might want to take some minor actions. This could be phoning the clearer/bank/broker(if sub shop) notifying them about the exposure. If you do this in good time before it gets critical (close to agreed limit) they wont be pissed either 
The above (above) scenario was about props setup using retail trading accounts for their activities. FASB150 Financial Accounting Standards don't apply to these types of firms. Nor does the aggregation of individual's trades. Crossing trades is internal and the software monitors that. The account number that a trader uses for one of these firms does not exist beyond the confines of trading office. All trades done on these "internal accounts" are recorded in the main retail account without prejudice. All that matters on these accounts is whether or not the main trading account (retail) balances out.
A majority of the firms who troll for traders/members are unlicensed and don't follow the rules the way a licensed firm like Bright or Hold or Echo would handle their business. This is where the murky waters come in. However there are plenty of "good guys" out there too.
I think people should know how both types of firms operate, Don, not just Bright.
(Just want to emphasize I am talking about the sub-LLC ubiquitous prop firms that advertise on CL and such, not the licensed and regulated firms like Bright, et al.)
edit: side note
Don, a licensed firm such as yours, you get 6.67:1 leverage on your accounts. Is that intraday and overnight as well or only for your intraday trading? (we're b/d, firm-wide, not individual)
A majority of the firms who troll for traders/members are unlicensed and don't follow the rules the way a licensed firm like Bright or Hold or Echo would handle their business. This is where the murky waters come in. However there are plenty of "good guys" out there too.
I think people should know how both types of firms operate, Don, not just Bright.
(Just want to emphasize I am talking about the sub-LLC ubiquitous prop firms that advertise on CL and such, not the licensed and regulated firms like Bright, et al.)
edit: side note
Don, a licensed firm such as yours, you get 6.67:1 leverage on your accounts. Is that intraday and overnight as well or only for your intraday trading? (we're b/d, firm-wide, not individual)
Overnight as well. Individuals get a lot more of course.
I'm curious about having one retail account and the short sale thing still. I can't be long and short in my Schwab account the same stock. If I'm not short I have to mark future sales short, regardless fo uptick rules or anything...they still have to borrow stock. If a bunch of guys are trading the same one account, and one guy is short GE and another buys 100 shares, would he not have to mark his sale as a short sale?
As I've stated before, I'm not a fan of these "retail" type porp shops, but I'll agree with you that there are probably a few "good guys" out there somewhere.
Don
We're not a retail operation, we are a broker-dealer (exchange member), have no customers, and all the traders are licensed (I'm sure there is more to it than that). To tell the total truth, I'm not sure of all the complexities involved....that's why we have an excellent Compliance Officer.
Another example might be (going out on a limb here).... Since Schwab is broker/dealer, each customer is treated as an individual, but each customer account has to be long/short compliant within itself (and each customer account is what you're referring to, not a broker dealer).
Best I can do,
Don
There's a lot more to it than that? What kind of books can you read to find out how the industry is set up or whatever? What kind of books does a compliance officer use to determine what's going on?