Jan 31, 20215 min read

10 Things You Need to Know from a Hedge Fund CEO

Tips from my book Trading Online will also give you a taste of being your own broker and what it is like to get into investment management.

My guide will give you a taste of being your own broker

All those kids’ thinking they are part of a political movement against hedge funds. Wait till they discover two things — first, we have no problems jumping on the back of the price moves they or anyone else creates.

Second, as probably the only retail trader in the world who actually then became a hedge fund manager — it’s not all it’s cracked up to be (more on that later).

Heck, I even wrote THE definitive book on trading that the Financial Times published. Each week in the paper wrote my Diary of an Internet Trader column.

What brokers do

The brokers are restricting trading because they cannot afford to take liquidity or reputational risk. Brokers are no longer often like estate agents matching buyers and sellers.

Realising that 78% of retail clients lose money (See risk warning on any UK regulated broker — US figures would be similar). They decided to be the Casino house instead.

If the retail clients act in concert, some brokers, of course, will trade alongside them if they know those clients have a track record of success — but they don’t have that data with the new accounts.

I’ve worked with a lot of brokers as an online trading authority thanks to all my books and actually doing it for a living. For the good brokers— reputational and liquidity risk are the two most important things to them.

Alpesh Patel CEO Praefinium Partners on BBC

And if these new accounts act in concert, i.e., conspire to manipulate the price, the broker can fail to be on the other side. So they will increase their margin to 100% to avoid this risk.

Why should a broker bankrupt themselves? Only an entitled millennial would think they have the right and blame the boogie man for stopping him from playing with his top computer.

2. Yes, you could be in the 22% who become winners and set up their Cayman Domiciled hedge fund as I did, but more on why that is not the dream in a moment.

3. Reputational risk brokers don’t like the death of clients, for instance. A Robinhood client committed suicide last year. So again, they place restrictions.

Alpesh Patel on BBC — Seen It All Before

What it means for the UK

4. The UK could suffer more than the US. In the US, most use options to gain leverage. A long call that increases in value as the share price rises will, at worst, cause you to lose 100% of your deposit. No more if the price collapses or the option expires.

In the UK, most trading in this type of stock is done on CFDs or Spread bets. So the broker will allow you to put down some margin and loan you the rest to cover the underlying notional value of what you bought.

Alpesh Patel’s Diary of an Internet Trader Column in the Financial Times

How Hedge Fund margins are calculated

This margin is calculated in the same way for hedge funds who also use CFDs — whether given volatility will the broker be able to demand and get funds from you. If the trade goes against you and if not, have ample time to sell your position and recoup the monies they are owed.

But this means you could easily lose more than your initial margin deposit.

Alpesh Patel Campaign www.campaignforamillion.com

Statistically, even Microsoft is more likely to be down in 25 days than in 250 days. So the likelihood of a margin call in a more volatile, less dependable company is greater, and the broker could be exposed.

Anyway, bottom line — UK traders are more exposed than US ones. Thankfully UK brokers are stricter gatekeepers (generally) to who they allow to trade.

5. This is not a paternalistic/libertarian movement — let us get rich, barbarians at the gates, like the kids, like to think. When they lose money, they will cry, “Why did no one stop us?” Wait, it’s coming.

6. Yes, in concept, colluding, you can make any price, even Bitcoin and Gamestop become the world’s most valuable asset (well, highly-priced asset anyway). That angers people, boomers, who know the difference between price and value.

7. Any hedge fund shorting liquid stock does not have your pension fund as investors. They wouldn’t be allowed. That they did it is a lawsuit waiting to happen too.

Managing your hedge fund risks

8. Yes, 22% or so do make money. More than in a Casino and more than as entrepreneurs, given that 90% of new businesses fail in 3 years. But as I’ve written in the Financial Times, it’s not the headline that helps make money, but risk management.

There is something the kids are on to; it’s just their raw talent for working out the internet, social media, communication online is being wasted. They are going into battles (not against hedge funds) but without the training.

Yes, derivatives like options and CFDs are weapons of mass financial destruction — which is why these kids should train themselves for their own financial well being.

Long term problems

9. The more significant problem will arise when they co-ordinate to short the S&P500. Never in history have so many had so many communications to do so much damage with so little money.

A flash crash is more than 50% likely, tripwires will kick in to halt trading. And there is a more than 50% chance these keyboard warriors will make a company like GameStop the most valuable in the world. And who knows, GameStop will raise money on the markets and make solar panels and be worth it.

After a year like 2020 and the way 2021 is shaping up — I am not in the forecasting business.

More about Hedge Funds

In the financial crisis, hedge funds were prevented from shorting banks. We cried, explained we were the good guys, but no one cared. Well, these kids are going to attack banks next — just as soon as one of them picks up a history book.

If I were a millennial today, and I’m in my 40s, having left practice as a barrister to trade full-time, then set up my hedge fund after some success. I’d go into fintech — sell shovels to brokers and their clients. In fact, my hedge fund does — that way, you win either way. Trust me, raising capital for a hedge fund from outside investors is tough — I know! Pull out the world’s tiniest violin.

Don’t get me wrong, being a hedge fund CEO has been great; it’s allowed me to serve my country, meet the Royals, go to Number 10, bring investment to the UK.

Being a hedge fund CEO has allowed me to serve my country, meet the Royals

But I’d do fintech today, so maybe if they crush my industry, it may not be a bad thing. A lot of clever people will go into doing public service and tech to solve bigger problems.