The Ups and Downs of Day Trading

Friday, July 30, 1999

(Jerry Knight photo by Reginald A. Pearman Jr. – washingtonpost.com)

Day traders buy and sell securities on a minute-to-minute basis. They often trade from computer terminals at offices like the Atlanta branch of All-Tech, where a disgruntled day trader allegedly walked in, pulled out 9 mm and .45-caliber handguns and began shooting on Thursday.

In a minute of well-timed purchases and sales, a day trader can make a fortune or lose one – making his a trying occupation. To cope with the inherent stress, All-Tech employs a corporate psychotherapist to help traders. Still, two-thirds of all day traders lose everything they wager within a month. The finances of about 90% of them don't survive the first three months.

I will be online Friday at 11 a.m. to discuss the profits and losses – both financial and personal – of dabbling in day trading. For background, read our special report on a day in the life of a day trader. Submit questions now.

Naples, Florida: Is there any benefit to the economy or the market as a whole from day trading? If not, why can it not be regulated-eliminated with exchange rules governing minimum periods of ownership?

Jerry Knight: The THEORY is that lots of little traders, buying and selling everytime the price of a stock moves a quarter or 50 cents, are good for markets because they add liquidity. Sort of like lubrication, they make things run smoother. In the vast markets we have, however, there is already such liquidity in most stocks that they don't make a bit of difference. These guys who now call themselves day traders used to be known as "scalpers" because they tried to shave a penny or two profit off each trade. Harvey Houtkin, the founder of the company where this crazy guy when off, called himself a "SOES Bandit" when he first started. SOES is Nasdaq's Small Order Execution System where blocks of 100 shares of stock can be traded at the push of a button. All Harvey and his clan did at first was try to find one dealer who was listing a stock for a quarter or an eight of a point less than the others, buy from that guy and sell to someone else. Now what they try to do is spot little trading patterns in a particular stock, try to get in early when it starts to move up, then jump before it starts to crash. It ain't rocket science, its trading by instinct. Think of it this way: serious investing is like playing chess. Day trading is a video game.

London, England: This has nothing to do with the perils of day trading. You don't hear about day traders in Japan shooting up people. This has to do with a major problem in Ameirca -- guns. I just wish our political leaders got a clue.

Jerry Knight: I'm half with you on this one. This doesn't have much to do with day trading, but I don't think you can blame guns either. This is a guy who Police think beat five of his relatives to death with his bare hands or some kind of crude weapon. Can't blame the NRA for that.

Bladensburg MD: It would appear on the face of it that the thrashing around that e-trading causes has GOT to be bad for the market. All the idea of a 'self-correcting' market is based on people taking reasonable chances on ventures that look profitable. Isn't this overheating an already hot market, and won't it cause some serious corrections down the road?

Jerry Knight: There is day trading and day trading. A lot of these full time traders who hang out in day trading salons are usually in and out of stocks in a matter of minutes. I think the greater mischief is done by the folks who use a little longer time frame, a full day, a couple of days. These are the people trading at home, by computer, through one of the ultra-cheapo brokers. They see some stock that's moving up and a couple dozen of 'em start buying, that exagerates the upward movement of the stock, makes it jump faster and higher than it otherwise would. When the stock weakens, the beat it all the way down, driving it harder and faster. That's making the market more volatile, more irrational, more unpredictable.

Rockville, MD: Does daytrader get startup money from the firm or they are wagering their own investment?

Jerry Knight: This is your money that you get to lose. Nobody's gonna let you learn this game with their cash. They'll let you use play money for a while. But once you get in, you pay the freight. Most people drop out quickly because they run out of money or they get burned on their early trades and decided to bail. This takes INTENSE concentration, not intelligence, attention. and it takes money.

Hegewisch, Illinois: Are "day-traders" like this guy involved in the Atlanta bloodbath in any way connected to the annoying pests who phone my office at all hours, uninvited, flapping their gums about this stock or that one...and who insult you if you don't want to buy?

Jerry Knight: Nope, those cold callers are a whole 'nother obnoxious wart on the market. Some of them are kids breaking into the brokerage business,calling people not at random,but from lists of potential investors. If you've heard of the firm the caller says he or she works for, that's a good sign. IF you've never heard of the firm, chances are unfortunately high that they're, shall we say, less than reputable. I've had out-and-out con men call me. Even top Securities and Exchange Commission regulators tell me they've gotten cold calls IN THEIR OFFICE from swindlers. RULE ONE: Dont buy any stock from somebody who cold calls you. EVER>

Mt. Rainier MD: Some of these e-traders are going to wake up and find out that, whether they've made any money or not, they've lost a life. And the chances are good that they've lost most of their money, too.

Jerry Knight: When I'm practicing amateur psychology, I diagnose day traders as compulsive risk takers. They're a notch up from ordinary gamblers, I think, because it may be possible to beat the system and make money. Odds are not good. Have you ever read a story about successful, retired day trader living the good life on HIS private island. More likely they're driving that tow truck and the island is a fantasy.

Greensboro, NC: Is there a minimum I should be ready to lose, before I start trading. And not cause any great panic within . I'm worth 650 TH.

Jerry Knight: First advice: find another hobby. But if you want to try, most of the day trading salons like the two that got shot up in Atlanta require you to put at least $10,000 into an account to get started. Some insist on $25k, a few might take $5,000. At the risk of sending you down a path that will cost you plenty, you might look at Attain.com, that's the website for all-tech investing. The most interesting thing I saw there was their admission that day traders are often people who are dead-ended in their real jobs. That frustration I guess is what makes you want to take risks in hope of breaking out. Not me.

Montecarlo, Paradise: Day trading is nothing more than obscene gambling. The whole investment environment, stocks trading at multiples of unheard proportions to companies earnings, is simply a wishfull thinking as pie in the sky concept. That does not mean some investors do not make money on the back of the unfortunate stiffs who want to make a quick killing. The stock market, in the short run, is a zero sum game. True investment return should mirror a company's ability to make profit with a narrow margin for error to its profitability. My question is: Should not average return, in the long run, be in then 10 to 15% range unless a company is profiting at a higher rate? What do you say?

Jerry Knight: Montecarlo, Paradise. If that's were I was, I wouldn't be on the net. You know too much about the fundamentals of investing to ever be a day trader. I absolutely agree with your basic concept: over the long haul the profits you can make on a stock are directly related to the profitability--and the growth in profits--of the company. What we're seeing in Net stocks however, is that the stock gains often come well before the real profits. Stocks are supposed to be leading indicators, they go up before the company prospers. There are people who will tell you the Net stocks are different,that the "new paradigm" somehow means Net stocks should trade a t higher price/earnings ratios than other companies. Over time, I simply don't believe that will prove to be true. But is has over the last few years.

Gaithersburg, MD: I'm confused as to what day-trading means for the companies involved. Is not the basis of all stock trading that there is some underlying faith in the company one invests in? Is not the very fact of people buying and selling seemingly on a whim destructive for the companies they invest in -and therefore for the economy as a whole-?

Jerry Knight: My personal view is that its an unproductive use of capital, but compared to what? People are spending $100,000 on Humvees to drive to the supermarket, just as big a waste of capital. I don't know of any company that can be identified as a victim of day-trading, at least not the few-minute horizon type. The momentum trading I mentioned early,the two or three day spurts, have hurt some companies. they make stocks volatile and scare away investors. for good reason.

Washington, D.C. : I read in today's paper that day traders often don't employ basic techniques such as selling a stock short when they believe a market will tank. They only bet on rising stock prices. Is this generally true?

Jerry Knight: When my collegue Steve Mufson went to visit a day-trading shop, he found most of these people don't have a clue about earnings per share, balance sheets,long term strategies. this is about TRADING. Juggling money. Some of the people who recruit and train day traders are honest enough to tell you up front, that traditional investment skills are more of a liability than an asset. These traders don't bet on who's gonna win a race, they bet on who's gonna be in the lead after half a lap.

bethesda maryland: How much does the daytrader who works at a place such as All-Tech have to pay for use of the computers and profits made on trades?

Jerry Knight: Depends on the shop. Some just collect commissions on all your little trades. Some do what amounts to renting the terminal to you.

Washington, DC: Not really a question, but I hope that people don't think that the way stocks are traded has anything to do with a very sick and disturbed person who committed horribly violent acts. I am worried about this tendency to find something to pin the blame on. It's like blaming the Columbine shootings on violent video games. Silly.

Jerry Knight: Definately with you on this. I don't think day traders are great contributors to society, but theirs nothing inherent in the business that will turn you into a mass murderer.

Washington: In a stock market that is valued as high as this one, are some people getting lured into day trading and other activities by the image being presented by the media? This image is one of rapid wealth, high living, and never-ending market gains.

It seems to me that a lot of these people don't realize that paper wealth is just that -- its nice to have, but if its rooted in speculation, it might disappear and you've got nothing.

Jerry Knight: Right on again. This phenom's father is the bull market. The mother of the invention is the technology that makes day tradint and online investing from home possible. When and iff the bulls stop running, I think day trading and especially online investing will fall way off.

Atlanta, GA: If the nature of day trading involves such volatility, shouldn't curbs or limits be placed on how much one can invest or sell? The Dow already does this on a global scale.

Jerry Knight: I have not heard any serious proposals for regulation. There are a couple reasons for this, I think. First nobody's getting hurt except the suckers who get into it and lose their money. Second the negative impact on the market is hard to measure and probably not that significant. Third, this is the era of anti-regulation. Neither the Republicans in Congress nor the Democrats in the Clinton administration want to try to regulate this. The GOP doesn't believe in regulation. The Democrats have figured out they aren't smart enough to regulate this market successfully. The roots of these day traders, the SOES Bandits i mentioned before, flowered when people like Houtkin found ways to exploit loopholes in regulation. That's the thing about technology, it evolves faster than any regulator can keep up with.

Rockville, MD: Is daytrader a fulltime job? or some work part-time?

Jerry Knight: Lots of part timers. or people who do it as a hobby. The hard core daytraders spend their entire day staring at a screen--or often two--watching for tiny little twitches in stock prices and trading patterns. Its intense. Very hard to do for a long period without Excedrin headaches and Maalox moments. The first shop like this I ever visited had folding tables set up in big rooms with computer cables runing everywhere and was filled with 20-something guys (100% testosterone-driven) scarfing down caffine hot and cold. Then they'd all go out and party to unwind.

Germantown, MD: Some Hio tech people in my company do day trading --that's going to stop--do you know if employers are liable for employee day trading loses if they occured during business hours?

Jerry Knight: I can't imagine holding the employer responsible, but there is probably some lawyer out there who will try to make that case. My friend Kirsten Downey who writes about work place issues is not here today, but I suspect she would say this is like people looking at porn sites at work. Not good for productivity. Potentially disruptive. I'll be there are companies that ban it. And others who would if they knew it was going on.

Mt. Rainier MD: Does it seem at all likely that the industry will stop over-promising - implicitly if not explicitly? The ads depicting 'ordinary' people making fortunes on the stock market were ridiculously off the mark. Instead ordinary people with ordinary resources are losing their shirts, which will lead to outbreaks periodically.

Jerry Knight: Those ads will vanish sometime after the bull market ends. The advantage of being an old fogey like me (I remember when the papers were full of the REAL Woodstock, not some rape and pillage event) is that I have seen markets go down, or go no where, for months, even years at a time. If we get back into a pattern like that, a lot of people will try to do day-trading casue long term investing wont work. Once they learn they can't make any money trading, they'll quit.

New York, NY: For Long Term Capital Fund, they are lucky to get helps from other big firms when they get into troubles. But for small investors, we never have any extra helps, say a loan, from big firms. Is it possible for the investment company to provide some sort of loans to you, when you get into trouble in the Market?

Jerry Knight: A couple of day trading shops have gone broke doing that. And others are in trouble with regulators for violating the rules on lending for investmetns. If you do not have the money to lose, you shouldn't be doing it.

Washington DC: Do you think the pressures and perils of day trading will get worse as the different stock markets move toward 24-hour trading for all? Will that make it next to impossible for the markets to rest -- and stockholders to calm down -- every day?

Jerry Knight: Good question. We do not yet have any clue about the possible and likely problems that will result from 24 hour trading. You can bet that there we be surprizes and they will not be all good ones.

FortWahsinton, MD: Does what the federal reserve effect day traders more so than say someone in it for the long haul??

Jerry Knight: Only if the Fed does something that causes stocks to become more volatile. You get a hectic day in the market becuase of a rate increse, and you get opportunities for day trading profits. Economic policy has a much greater effect on long term investment that are related to the health of the economy.

New York, New York: All we hear is the negative side of day trading. Isn't it true that when the market was going up consistently, people were in fact making money on day trading?

Jerry Knight: Sure. It's not hard to make money buying stocks when the market is going up. Some people think riding a long term bull market proves they are financial wizards. I dont agree.

Rockville, MD: Is it true that all the daytrading firms have the samiliar technology that allows you to trade on demand. in other words, do daytrader lose money because they couldn't process the transactions fast enough? Any guanrentee from the firm?

Jerry Knight: The day-trading shops usually claim their software is better than anybody elses. Check out the Attain.com site to see what I mean. My guess is those claims are about as valid as the ads that are used to sell toothpaste.
As for execution. There are NO GUARANTEES. Reputable house like Schwab have bailed out investors who got nailed because of system failures. I douldn't count on that happening. We know from high volume days in the market that the online brokerage houses can be swamped. Trades don't get executed at the prices people want. Trades don't get done at all. If we have another big one-day crash, another Black Monday, I would not want to count on using an online brokerage to sell my stocks.

Falls Church, Virginia: As I have read some questions and your responses, on question comes to mind, if the potential for most all day traders to lose money is there an ethical responsibility for these investment firms to disclose this potential or make it mandatory for day traders to go through some kind of training so they will understand the requirements-INTENSE CONCENTRATION- required.

Jerry Knight: Ethics and day trading shops. Hard to use those two terms in the same sentence as far as I'm concerned. BUT that said, the better ones--including All Tech, the last time I knew--do require you to be trained. They run courses, let you play with funny money, off line, for a while. I don't think suckers are being lured into day- trading. I think they are luring themselves.

Charleston, SC: With such a high failure rate, what motivates someone to get involved in day trading? Is it for the potential to make a lot of money or the thrill in risking it all?

Jerry Knight: Its a game. its fun. if you're into it. I'm not. I believe in old-fashioned buy and hold investing. I'll buy Powerball tickets, but I won't day trade. (For the record, Washington Post financial reporters are prohibited by our ethics rules--and our good sense--from doing short term trading as well as banned from investing in any stocks we write about.)
Thanks for logging in with me today. It's a delight to message back and forth with knowledgeable readers. That's all, for this session, but you can e-mail me: knightj@washpost. com. Chow, baby.