Comment by zaroth | Hacker News Reader

Comment by zaroth | Hacker News Reader

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If you buy and sell shares within the same day three times in 5 business days, you will be flagged as a “Pattern Day Trader” and you’ll need to post at least $25,000 of collateral.

I don’t think the problem here was with too many trades. Very few Robinhood accounts overall have over $25k balance.

I guess I can’t see where the risk is. Shares are moving electronically between different ledgers as orders are fulfilled. Shares aren’t being created or destroyed, nor is money.

I can definitely see how you could end up with large net cash flows that need to settled over the next 48 hours, if Robinhood accounts are collectively gaining or losing huge percentages of their value from one day to the next. But I don’t see, absent allowing margin or naked options, how they could ever end up owing more than they actually have on hand in their custodial accounts.

I would possibly believe that Robinhood didn’t have the technical controls the fix the problem that they were having the “right” way, and had to resort to their “least worst option”.

For example they should have the technical controls to flag specific sales to prevent those funds from being reinvested until the particular sale settles. By free and clear settled cash should be able to buy any publicly listed share it wants.

> Shares are moving electronically between different ledgers as orders are fulfilled

Ah, this is the disconnect.

They're not. Shares and payment for them move within two business days [1]. In the meantime, both sides must post collateral as a guard against their failing to deliver.

You're a broker. Suzy has $20 in her account. Suzy sells a share for $10. She buys another share for $10. With the first trade, you have to post--today--collateral against that $10 for two days. With the second trade, you have to post--again, by close of business today--collateral against that $10 for two days. To keep things simple, let's assume Suzy did not use the proceeds from the first sale to finance the second. That leaves you with $20 of liabilities and $20 of cash.

Next day, Suzy sells all her shares for $40. Now you're putting up collateral against that $40 for two days. The $20 from yesterday still hasn't arrived from JPMorgan--they have until tomorrow. You now have collateral against $60 of liabilities. At the end of the day, Suzy makes a withdrawal request because she's a little shit. So now you have $80 of liabilities from someone who deposited $20 in her account and never had more than $40 of assets.

Clearinghouses use the last day's closing price to determine how much collateral you need to post. They then multiply that by some value that ranges between 2% and 100%, depending on what their line-of-credit lenders offer them. That is leverage. To manage that risk, the clearinghouse adjusts that multiplier. Going from 20% to 100% in the above example would mean going from $16 of collateral required to $80. That's $64 of cash you need to come up with before the end of the day or you're out of business.

If Robinhood operated with zero clearing leverage, they would not be able to offer the instant-trading experience their competitors have offered since the 1990s.

[1] https://www.investor.gov/introduction-investing/investing-ba...

This was an extremely eye opening thread. Thank you for explaining it in such clear and concise terms.

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