Is Momentum/OIA such a great business?: "The Two-Front War In the day-trading world, you've got to beat the market -- and the commissions By Richard Karp
David Reiter considers himself a successful day-trader; over two years, after all was said and done, he lost $75,000. Back in 1996, when he stumbled onto the trading game, the now 60-year-old Floridian was looking for a new type of work. Reiter didn't know much about the stock market, but
he was an experienced businessman. For his entire adult life, he had run a Chicago-based chain of home-furnishings stores, founded by his family in the 'Forties. But by the mid-1990s, the Reiter shops could no longer compete
with the Wal-Marts and Kmarts of the world. Because the stores were heavily in debt, no ready buyer could be found. Instead, the half-century-old concern was liquidated, and David Reiter's share of the proceeds apparently
didn't amount to much of a retirement nest egg.
"So I was looking for a new career which would earn me enough money to
spend half the year in Florida and half in Chicago," explains the low-key
Reiter.
While contemplating ways to make this idyll a reality, the unemployed retailer
chatted on the telephone with a friend in New York City, who told him about
day-trading via SOES (an acronym for Small Order Execution System),
which allows day-traders to nab some of the gains that market-makers in
various stocks usually get on the spread between bid and asked prices on
trades, but which has since been largely replaced by a less head-butting
system. The friend, who ran a New York day-trading firm, told Reiter that he
couldn't explain SOES over the phone, and advised him to come to the Big
Apple to learn the ropes firsthand.
Reiter did just that, and came away confident that he had, indeed, found a
promising new career in SOES trading, or what is often called "scalping" --
hit-and-run trades that nibble at stocks for quick profits.
That roughly translates, in Reiter's
words, into "a one-minute trade-in
and out. You may notice on the
Level II computer screen that, in an
active stock, say Intel, offers, or sell
orders, are suddenly disappearing.
So you figure the stock will rise, and
you punch in a bid for 1,000 shares.
If you're right, you sell out a minute
later when the stock moves up an
eighth or, maybe, a quarter of a
point." An eighth-point uptick would
produce a gain of $125; a quarter-point, a $250 profit.
"When I started out day-trading," he continues, "I thought: How difficult could
it be to make a quarter-point just four or maybe five times a day? That's at
least $1,000 per day, or an annual income of $250,000 a year. It seemed
easy, and I could see myself in semi-retirement, maintaining those two homes"
in Chicago and Florida.
With these blissful thoughts, Reiter began trading, in September 1996, at an
established Chicago day-trading firm. And the first thing he was told by the
firm's principals, he recalls, was that it didn't pay to trade fewer than 1,000
shares at a time. (At the time, the maximum number of shares that could be
bought or sold on SOES was 1,000; subsequently, regulators reduced that to
100.)
The suggestion made sense. After all, the firm charged $25 per trade, or $50
per round trip -- a purchase and subsequent sale -- regardless of whether
500 or 1,000 shares changed hands. And it certainly didn't pay to trade
fewer than 500 shares, since the profit-per-share the day-trader was trying to
skim away from the market was so small.
Like most novice day-traders, Reiter had to move painfully up a "learning
curve," splattered with red ink, before getting the knack of the fast-paced
game. In the first month, according to his reckoning, he made 94 round-trip
trades: 39 were winners; 49 were losers; six were washes. In dollar terms, "I
lost $4,200 trading and paid out $4,700 in commission fees -- a total loss of
about $9,000." In the second month, he was down close to $16,000:
$10,400 on trades and $5,300 in commissions.
The third month was no better. He suffered $4,100 in trading hits and paid
out $3,700 in commissions -- a total of $8,700. The fourth month, found him
back in the vicinity of the first month; he lost $9,400, reflecting $5,400 in
trading losses and $4,000 in commission expenses.
Then came the turnaround -- sort of.
"After the first four months," Reiter emphasizes, "I never again had a month in
the next two years where I lost any money trading stocks." So how did Reiter
ultimately end up in the hole for $75,000? The culprit, in a word:
commissions.
The math is easy to comprehend, even though many day-traders feel they can
beat it.
If you make $125 on a trade and then shell out a $50 commission, you net
just $75. But if you lose $125, you're really down $175, once the
commission is added in.
Win on two out of three such trades, and you're still down $25. Laments
Reiter: "If you win two out of three games in Las Vegas, you're a winner --
but not in day-trading."
In fact, to come out ahead by scalping eighth-point gains, you really have to
rack up three winning trades for each loser. And when it comes to the stock
market, being right 75% of the time isn't easy.
Adds Reiter: "At the end of two years, I gained $25,000 in trading profits,
but paid commission fees of $100,000; the commissions just ate up my
profits and killed me."
Or perhaps Reiter wasn't bold enough.
That, at least, is what his mentors at the day-trading firm implied, when he
mentioned to them this peculiar arithmetic. "Since I was making about 150
round-trip trades per month, or around 10 a day," he continues, "I was not
considered an active trader in this business, but what they called a
'low-volume' day-trader. I was told the most successful day-traders were
those who make 100-200 trades each day."
But that argument has one snag, Reiter maintains: "I never met any day-trader
I considered consistently successful. And if there were success stories, I
could never find out because nobody would share information in the
day-trading salon. The only way I could judge who might be successful was if
they stayed for a long period of time." But, he adds, "I never saw very many
of those people."
Of course, some people do win at day-trading, as was made clear earlier this
year in an article in Barron's ("Weird Science 101," March 1). But as that
story also noted, many people who take day-trading courses never get up the
courage to take on the market, and most of those who do don't succeed.
Does Reiter still day-trade? "Yes and no," the South Florida resident
answers. "I will probably trade a little, but with a Florida firm, and maybe I'll
hold stocks for the longer term -- but I won't play the 'scalping' game. So
right now, I'm seeing if I can make money trading stocks short-term and
long-term -- though I haven't been successful yet."
If Reiter recounts his ill-fated experience as a computerized scalper with a
surprising equanimity, quite the opposite is true when one speaks with another
former Chicago day-trader, John Skiersch.
Skiersch's unconcealed bitterness has turned him into a self-described
crusader against day-trading in all its manifestations. "I'm not crying 'sour
grapes,' " Skiersch says, "I'm screaming 'poisoned vineyard!' "
And little wonder. In approximately one year of sitting in three different
day-trading salons, Skiersch contends that he traded $200 million worth of
stocks, and paid over $120,000 in commissions.
In that one year, he lost $200,000. Much of it came from an inheritance, but
the toll also included his condominium and a $30,000 advance on his credit
cards. "I lost my home, I lost my girlfriend, I lost my family members, and my
health has declined dramatically," he says ruefully.
Moreover, Skiersch asserts: "There are hundreds and hundreds of victims like
me, but they're scared to come forward," many because they'd be mortified
to admit that they've lost a lot of money.
The 33-year-old Skiersch, however, isn't uncomfortable in the spotlight, even
if it throws a very unflattering glow on his stock-market prowess.
With a long ponytail, a guitar sometimes cradled in his arms and often attired
in bright sequined cowboy outfits, the Chicagoan is a professional entertainer,
whose stage persona is Johnny Vegas, the Disco King.
At clubs throughout the Windy City area and elsewhere, he sings, dances,
strums, jokes, parodies; in short, he's a one-man traveling vaudeville show.
Like most performing artists, he is often between gigs. And like many
theatrical folk, his knowledge of stocks and bonds was practically nil. But that
began changing -- or at least he thought it did -- on a spring day in 1997,
when he fell into a conversation with a friend who was a stockbroker.
The friend accompanied Skiersch to a day-trading house and introduced him
to a buddy who was one of the firm's customers. At first, Skiersch just sat
behind the day-trader, looking over his shoulder at the computer screen as
the latter feverishly punched in about 100 trades a day. He could only watch,
not talk, lest he upset the trader's concentration. Such was the substance of
the actor's basic training, which lasted a few days.
At which point, the firm's managers approached Skiersch, and -- he contends
-- parted the curtains on a potential El Dorado of riches. As Skiersch
recounts it, they told him they had invented a technology that was so
innovative and fast, they were years ahead of the "old dinosaur" system, i.e.,
calling a broker who then called a stock exchange.
In other words, Skiersch explains, "They were going to teach me how to
scalp. They talked about 'instant fills,' and how one could just 'point and click'
on a computer screen and complete a trade in three seconds, 'at the price you
want ...' They said we could run circles around this dinosaur of a system that
was too big to be fast enough to catch us."
Eventually, however, Skiersch learned that this big old dinosaur could be a
Tyrannosaurus Rex that "ate everyone alive."
Skiersch's naivete and willingness to accept what he believed certainly
contributed to his downfall. He also apparently didn't have the discipline to
cut his losses quickly enough -- something day-trading companies say is
perhaps the most common cause of their clients' losses.
In the beginning, Skiersch continues, "I believed what they told me: an
unlimited upside and no end to what I could make," he recalls. "And they said
the only thing stopping me was my fear to pull the trigger."
Moreover, Skiersch adds, his mentors delivered a message that seemed quite
plausible, in that it combined sensible warnings with exhortations to plunge
quickly into the fray, since that was the only way to really do well. Skiersch
and the other novice day-traders in his group, who included a United Parcel
Service driver, a cell-phone retailer and a haberdasher, were taught a strategy
calling for 50-100 trades a day, and were cautioned to take only 1/16- or
1/8-point profit per trade. "Anything more was unrealistic," they were
warned.
They were advised that, if they restrained themselves to these small gains,
they could net, after commissions, $80 a pop in a minute. And they were also
cautioned, explains Skiersch, that "if there was ever a tick against you, you
immediately sold the position, cutting your losses as quickly as possible; and
that you could buy it back seconds later, just before it went back up again"
(what is called the "bounce").
But, at the same time that the firm's managers were delivering these words of
caution, they also created what Skiersch calls a "sense of urgency." They
hammered away on the theme, Skiersch recalls, that "the only way to learn is
to get in there and trade."
So, after filling out a questionnaire ostensibly designed to judge whether he
was a suitable candidate for day-trading -- it consisted of a one-page
checklist, noting income, assets, net worth, etc. -- the actor sat down in front
of a machine in the trading salon. He was totally on his own, with no one to
advise him, "no supervisor, no risk-control manager," aides that some
day-trading outfits say they provide.
The firm required a minimum trading account of $25,000, but the optimistic
song-and-dance man voluntarily plunked down $50,000 to start. "Evidently,
even that was not enough capital," Skiersch recounts, "and they suggested I
should sell my condo apartment, which I did -- and that was only two weeks
into my day-trading life. So I was soon working with $100,000."
And soon Skiersch began twigging to the real
dynamics of day-trading. He discovered that the
recommended strategy of punching in and out of
positions quickly, even after a downtick, didn't
work most of the time. "I learned that markets
don't move in a straight line," he explains. "They
bounce around, or chop, as they say. Which
means that if you hold a position for a minute or
two, 80%-90% of the time, it's going to tick
against you."
More importantly, Skiersch began to perceive
that while the day-trader could be a big loser, the
day-trading firm was almost guaranteed to be a
big winner.
"If, at a $25-per-trade commission fee, you make 50 round trips in a day, at
$50 a pop, you just paid the firm $2,500; or, on a busy day where you do
100 round trips, the commission cost per day is $5,000. So to have a
profitable day, first you had to be right with the market -- which was about
half the time -- and then you had to be right enough to cover your
commissions."
Skiersch remained at this day-trading firm for five months and, by his own
reckoning, generated $57,000 in commissions for it during that stretch. "I
didn't make any money on trading either, and I realized," he recalls, "that
paying $12,000 a month in commissions meant I was never going to make
any money there."
Despite his growing losses and uneasiness, Skiersch showed no self-restraint.
He kept trading, switching, on the advice of a fellow day-trader, to another
firm with a lower commission rate in the fall of 1997.
There, he says, he found nothing better. For one thing, this firm seemed to
have no expert managers at all, but rather just "another day-trading customer
who answered questions if he wasn't too busy trading himself." Worse, as
Skiersch soon discovered, this customer "received compensation based on
the volume of trading in the salon."
Much more significant, this second firm required prospective day-traders to
fill out a U4 Form, a document that licenses "professional traders," after they
pass a series of exams. In this case (as with hundreds of others) Skiersch's
U4 was filed with the Philadelphia Stock Exchange, which, until a rule change
approved by the SEC this past August, simply approved the applicants as
legally registered brokers without requiring any such tests.
In short, Philadelphia was considered a "safe haven" for day-traders; or,
more to the point, a way for day-trading brokerages to skirt any liability for
their newly anointed "professional" customers.
What this meant for Skiersch, he would soon find out. In two months, he paid
out $12,000 in commissions, and lost $48,000.
But of the $36,000 he lost in trades, Skiersch claims $30,000 was lost in a
mere two days "because of the firm's computer malfunctions."
When, in the course of seeking restitution, he asked to see his trading
records, the firm refused on the grounds that "my U4 filing made me a
professional and thus, they didn't have to provide me with my own trading
records. And that's why I left the second place after two months," he
explains, "mainly because of those unexplained two-day trading losses."
Despite all this, Skiersch went to a third day-trading firm where, in the course
of six months, he lost another $80,000, and finally accomplished his financial
ruin.
All of which raises an obvious question: Why didn't he learn his lesson
sooner? Replies Skiersch, in what may be a true psychological insight or
simply a rationalization: "Because there are no losers in a trading room. The
only people you meet are beginners with a grand illusion. Those who have
lost their shirts are already gone from the scene. So there are no wise men, no
gurus, to warn you off -- they're broke, and gone."
Moreover, Skiersch continues: "It's my conclusion that the day-trading firms'
basic strategy is to burn everyone's money out and get rid of them; and bring
in more and more new traders. When the market turns down, it will be a
catastrophe." As it already has become for him. |
