That Uncomfortable Shoulder Tap

An article in The Wall Street Journal yesterday brought back memories and created some chatter around the office.

A rising star at a leading hedge fund got that uncomfortable tap on the shoulder. The tap I’m referring to is the gut wrenching notice from your risk manager that he’s cutting you off. When a trader in a prop shop exceeds their risk limit or breaches a downside P/L limit the risk manager used to stride over to their desk and tap them on the shoulder to inform them…berate them possibly…about proper risk measures. The trader would be told to close their positions. Essentially the risk manager would take their ball and tell them to go home.

Years ago, when many of us cavemen toiled away in the pits, you’d occasionally see the comical sight of a poor margins clerk amble their way into the pit and attempt to stop a fiery trader from trading. This could make for a scene. Envision the prototypical accountant squaring off against the star linebacker from your high school football team. They exist and speak on very different fields.

The methods have certainly changed and most trading operations have these risk measure automated. Breach a level and the risk monitoring software will immediately jump into action to shut you down.

What was most interesting in the article was the method used by the trader to get around risk. Exchanges have different margin or risk parameters based on the time of day. That sounds silly doesn’t it? At 11 am they require less risk collateral than they do at 11 pm. There’s day, or session risk, and overnight risk. The reasoning is sound as the markets have more liquidity during the their primary, day, session. There is more active trading so the risk managers, should they have to, can get out of the position without too much price risk or having to pay too deeply into to the market in order to close the position.

What this trader did, and what many, many traders do, is he held large positions during the day, when liquidity is thick and less margin is required, and scaled back his position at night when the exchange, and risk manager, required more margin. This is not at all uncommon. It appears however this trader may have been getting around the position limits imposed by the firm.

The article goes on to note the strategy was making money. The trader was doing well. So why cut him off? Simply put the rules are the rules and Wall Street has changed. Winning at any cost has been scaled back to make money within our guidelines. There’s nothing wrong with that. Risk maintenance trumps risk profits.

As the story wound down, it was noted the positions turned and ended unprofitable. Would he have gotten out before the trade turned? It’s tough to say. One mans risk is another’s reward.

Show your support

Clapping shows how much you appreciated Patrick Rooney’s story.