Putting your neck online
Investor (Special supplement in the Independent)
Day trading is fun, fast and furious. But is it also profitable?
Online investors are often known as "day traders," but the term also refers to a more intense kind of internet trader who, although with much in common with online investors, has a narrower focus more akin to gambling than conventional investing.
Does a company earn money and have good growth prospects? Is it vulnerable because of new competition or a changing marketplace? These and related balance sheet questions preoccupy ordinary investors, whether online or off, who make investment decisions based on their considered judgments about various companies.
Online investors are regarded as daytraders in that many of them spend between six and 16 hours per day monitoring their investments and trading. Some have given up regular jobs to do so.
The other kind of daytrader seeks to make a killing on share price movements of a fraction of a point, and usually sells shares within minutes, even seconds, of buying them. These day traders also generally end the day owning no shares at all, disposing of all of their holdings before the market closes. They don't want to find nasty surprises the next morning due to overnight trading. The theory behind this kind of trading is that if you do it enough times a day, buy enough shares each time, and pick more winners than losers, pennies multiply into tens of thousands of pounds.
What a difference a few days, and a few hundred points, make. Until a few weeks ago, some of these daytraders were riding high and making vast profits on their kind of market, a volatile one. Suddenly, however, many are licking their wounds.
But a method of investing which can yield high rewards is inherently one which also harbours high risks. In fact, at any point in time many daytraders are hurting because in general the majority lose more money than they earn.
However, as soon as the market calms down, many online investors may be tempted to give daytrading a try. American firms are opening offices in London and elsewhere, and the regulatory and cultural climates are changing.
I recently visited the trading floor of InvestIn in the City, in the middle of a highly volatile week. Technology stocks had been clobbered a week earlier when Microsoft lost its anti-trust case, and the freefall had not yet ended. Indeed, two days later, both the Dow and the high-tech NASDAQ were to drop seven and ten per cent respectively. Volatility is supposedly manna from heaven for daytraders, who concentrate on turbulent high-tech shares, but only one trader was present.
At InvestIn, traders sit before two massive interconnected screens linked to powerful servers. So mighty are the software and servers that it is like sitting before ten ordinary PCs. The room also contains several TVs all tuned to CNBC, a financial station providing continuous news and stock market analysis. Indeed, while I was there CNBC was transmitting a live broadcast of Alan Greenspan's testimony before the U.S. Congress. As chairman of America's Federal Reserve Board, Mr. Greenspan's pronouncements are market-moving news. The 21-inch computer screens are capable of displaying several charts and other kinds of information simultaneously. Huge amounts of data are instantly available.
InvestIn software has a training mode that enabled me to trade as if I were a bona fide daytrader; that is, the software provided the same results as if I were actually trading. My positions, profits and losses, could have been real.
The software enabled me to set alerts so that, instead of monitoring the price of a particular company, I could receive visual and audible alerts when the price rose or fell to values I specified. These alerts enable traders to perform other tasks while selected shares are automatically monitored. They also allow you to track more shares than you could conceivably monitor directly, and you can even turn away from the screen without worrying that you will miss your target. Many free web sites enable investors to make charts of their favourite shares but when you access the site, you see the price only at that instant. To get updated prices you have to hit the refresh button. With professional day trader software, you specify your five or 15 or 50 shares and their continuously rising and falling prices instantly appear on the screen, green for up and red for down.
Buying and selling shares through a broker, like buying and selling foreign currency, involves such a spread that you lose a bit when you buy in another bit when you sell, and for this privilege you also pay commission. Direct access day trading does away with the spread. You see the actual buying and selling prices of the different marketmakers and deal directly with them. Marketmakers are the brokerages and banks, like Goldman Sachs and Morgan Stanley, who quote buy and sell prices and guarantee those prices.
Another advantage of powerful daytrading software is that it leaves you in no doubt concerning the execution of your transactions. When I clicked to buy or sell, I was notified in seconds that my trades had been accepted. Execution is a major problem for amateur investors. According to www.daytrader.co.uk, “You need to have fast, timely executions and confirmations. Nothing is worse than not knowing if you are in or out of a position. We cannot emphasize this enough. Bad executions can cost you a lot of money."
I was able to track the price of one stock on a second by second basis so that I could buy it on the instant it rose from 97 to 98 1/16, and sell when it hit 98 5/16. I made a few trades and ended up slightly in profits. Trading like a professional, with complex constantly changing screens, and bypassing brokers to dealing directly with marketmakers, is seductive. It is easy to see how some people can get hooked. But the reality is that for every day trader who ends up in the black, approximately two shed red ink. And because daytraders tend to engage in margin trading--in effect, using borrowed money--red predominates when they fluff it.
The financial advantages of direct trading are offset by certain costs. For one thing, there is a fee per trade, and a "round-trip" of a buy and sell constitutes two trades. Trading fees these days are modest--£10 or so, much reduced from the £100 or more per trade that applied in pre-internet days--but they add up, especially considering the many trades per day of the typical daytrader. America's Securities and Exchange Commission cites a hypothetical “day trader who makes 50 trades per day at a firm with moderate fees ($16.70 per trade, $150 per month). This trader must generate $16,850 each month in trading profits to recoup the costs of the trades." In Britain, too, the odds are further stacked against the daytraders by stamp duty.
The costs are as nothing compared with the downside of margin trading, a practice which allows investors to play with more money than they have. But when the losses are called in, as occurred to many investors recently (and not just daytraders), the depth and suddenness of the indebtedness can be devastating.
The system does not allow for unlimited debt. With margin trading, if the daytraders shares drop to a point where they have exceeded their borrowing capacity, they must cough up some money, either in cash or by selling their remaining shares--shares which they might prefer to hold, and which might prove profitable eventually and bail them out of their current hole. They have no choice: their shares are sold automatically.
With losses spiralling out of control due to a margin call, an investor who starts with £100,000 can suddenly be £150,000 in the red. And due to formulae that apply to margin trading, the day trader may owe a good deal even on days when they end up flat--showing neither profit nor loss. Daytrading should come with a health warning on the side of the pack, and indeed it does (see Warnings below).
Warning 1: The SEC
In May 1999, Arthur Levitt, Chairman of America’s Securities and Exchange Commission, defined a day trader as “an individual, not registered as a broker-dealer or as a registered representative, who trades stock at a firm that allow[s] the individual real-time access to the major stock exchanges and the Nasdaq market”.
Levitt told the US Senate: “Day trading is neither illegal nor is it unethical. But it is highly risky.”
You need wealth, the time, or the temperament to make money and to sustain the devastating losses that day trading can bring.
Be prepared to suffer severe financial losses—many traders never graduate to profit-making status.
Daytraders do not “invest.” True day-traders do not own any stocks overnight because of the extreme risk that prices will change radically from one day to the next.
Day trading is an extremely stressful and expensive full-time job.
Day traders will depend heavily on borrowing money or buying stocks on margin.
Don’t believe claims of easy profits. Before you start trading with a firm, make sure you know how many clients have lost money and how many have made profits. If the firm does not know, or will not tell you, think about the risks you take in the face of ignorance.
Watch out for “hot tips” and “expert advice” from newsletters and websites catering to daytraders.
Remember that “educational” seminars, classes, and books about day-trading may not be objective. Find out whether a seminar speaker, an instructor teaching a class, or an author of a book about daytrading stands to profit if you start day trading.
Check out day trading firms with your state securities regulator
Warning 2: NASDAQ
The NASD (National Association of Securities Dealers) in the US has also recently defined a daytrader as “an individual who conducts intra-day trading in a focused, consistent manner, with the primary goal of earning a living through the profits derived from this strategy.”
Day trading in shares can be extremely risky
Be cautious of claims of large profits from day trading.
Day trading requires knowledge of securities markets—you must compete with professional, licensed traders employed by securities firms.
Day trading requires knowledge of a firm’s operations— including its order execution systems and procedures.
Day trading may result in your paying large commissions.
Day trading on margin or short selling may result in losses beyond your initial investment.
Case Study
"I’M TRADING AT MY SCREEN FOR 12 HOURS A DAY. I LIVE FOR IT."
IF YOU have a sufficiently powerful computer, you can use professional day-trading software at home. Primark, a global Information service provider offers a broadcast product and a website.
“The broadcast product, PC Market-eye, is a data and information feed which we send as a TV transmission and you receive it via your TV antenna linked to your computer,” explains product manager Richard Barden. “We provide a streaming real-time feed, and there are no phone charges, which is an important factor in the UK. We provide real-time information on many shares at a time. It costs £1,000 per year and is for sophisticated, not casual investors.”
Leeds-based Jess Illingworth and his son Bryan are Primark subscribers and they are wired for sophisticated trading, although their variety of ordinary online trading is altogether more leisurely than the frenetic mouse-clicking of the lnvestln type of daytrader.
Formerly in the carpet business and now a full-time investor, Bryan says he makes only one or two trades a day. “I’ve been investing since 1986, and seriously for the last seven years. The highest number of trades I made in a single day is about ten.” The other kind of daytrader chalks up that number in an hour or less.
“We use two computers, AMD600s, with three screens for each, plus a TV tuned to Bloomberg. One screen might show prices, another news, another options, charts or tables’ says Bryan. “I did a few trades today already. I trade the London Stock Exchange and follow the American markets. I’m at it for 12 hours a day. I live for it’
The Illingworths combine internet and traditional investing: “I execute by phoning my broker:’ says Bryan. “I prefer the personal contact, and I might be after a price. Sometimes with options I don’t get it when I want, but I do get stocks at the best price.”
Do they ever argue? “All the time,” says Jess, the father. “Bryan is more full-time than me. I do it only about an hour a day, so I leave it to his discretion. I can spend hours on the computer getting things working rather than actually trading. Things always go wrong. Yesterday morning, only the FTSE was working. The options screen was down all morning.” A week earlier, on 5 April, the crucial last day of the tax year, the entire system was down.
For Jess, online investing “is a good way to spend time and increase the bank balance.” But his advice to anyone thinking of doing the same is to “first test your investing system before you actually invest to see that you can do it successfully.”
www.robertliebman.com