Q&A

Since You Asked

with Don Bright

Confused about some aspect of trading? Professional trader Don Bright of Bright Trading (www.stocktrading.com), an equity trading corporation, answers a few of your questions. To submit a question, post it on the Stocks & Commodities website Message-Boards. Answers will be posted there, and selected questions will appear in future issues of S&C.

MARGIN CALLS WITH PORTFOLIO MARGIN
I have been trading for many years, but I have some concerns regarding my broker. Although I was promised something called “portfolio margin,” which was supposed to have a leverage of six times my capital, I have received margin calls when using a much lower amount. Should I pursue other alternatives, such as trading with a firm like yours? How does your firm, and others like yours, monitor the risks taken by its traders? How do you ensure that traders don’t blow out a lot of money? I have heard horror stories from some traders. Am I missing something here? I hope you can clarify this for me.—Natofan

You have good reasons to be concerned, and your questions address some things that are often misunderstood.

Let’s talk about portfolio margin first. Retail brokerage firms have been offering 6:1 leverage to their larger accounts — accounts of around $100,000. This can work, but unfortunately it often doesn’t. The brokerages can decide on their own that you’re too risky for them, and they can invoke their own risk tolerance to give you more restrictions. This has caused a problem for many traders I know, and it’s something you need to be aware of.

Things are different in our world of professional trading. Our traders are using our money to trade with, entering trades that may be 50 times their equity, such as with the opening-only play and correlated pairs. Our traders may, for example, enter a large number of orders premarket, in anticipation of getting filled on only a few extreme cases where they can make quick profits. This generally cannot be done with a retail account, with or without a portfolio margin feature.

Let’s move on to risk control. At Bright Trading, we take risk control very seriously, since most of the trading capital comes from us, not our traders. At the same time, we want to give our traders the flexibility to trade as they please. So we set guidelines — some more stringent, and some that can be modified trader by trader. Many traders, for example, may use 30 times their actual equity (we call it “net liquidating value”) overnight in hedged positions. This allows for what we consider “flattening of the risk curve” when trading pairs and mergers.

The concept of risk control, of course, falls on the traders themselves. We do offer them some assistance in this regard. We have technology that will trigger a “liquidation only” status on their account if their net liquidating balance falls below a certain level. The traders themselves can use this system to put their own parameters in place as well. In addition, we have supervisory software that alerts management if a trader is losing more than 10% of their value, or making more than 25% of their account value. Either one could be because of too much risk, which is sometimes just an anomaly for that day, but by working together with our traders, we can circumvent a problem before it gets too big. Normally, we communicate directly with the trader, discuss the situation, and determine the best course of action.

I applaud you for searching out alternative places to trade. Your questions are solid, and I hope I’ve helped a little. We are very fortunate to have some of the best traders who help each other in many ways.

SHORT-TERM DIVIDEND PLAYS?
I have a question regarding dividend plays. I’ve heard the term many times but don’t understand it. I realize that when you hold stocks, you receive dividends, but what is meant by the “short-term play?”—Tradwinr22

Good question, and oftentimes a good strategy. I can use a recent (March 2013) example to show you what short-term plays are. Many of our traders like trading pairs of stocks (short ACE, long CB, for this example), while others like to play the individual stock (CB for this example).

As you can see from the spreadsheet in Figure 1, CB paid a dividend to shareholders holding long stock on March 12, 2013. Understand that on the ex-dividend date (March 13, 2013, in this example), if the stock were to open unchanged, it would have been 0.44 cents lower than the $85.69 closing price of March 12, 2013, or $85.25 (unchanged). The actual opening price is determined by the market that day.

FIGURE 1     *Close price adjusted for dividends and splits

In this example, the stock closed higher than the previous day, so you could sell the stock at a profit and collect a nice dividend — thus, a “dividend play.” Hope this helps.

Originally published in the May 2013 issue of Technical Analysis of Stocks & Commodities magazine. All rights reserved. © Copyright 2013, Technical Analysis, Inc.

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