Day Trading Can Lead to Big Losses,
Dangerous Illusions, Specialists Warn
By REBECCA BUCKMAN and RUTH SIMON
Staff Reporters of THE WALL STREET JOURNAL
August 2, 1999
Glued to fast-moving computer screens and surrounded by the busy clickety-clack of keyboards, some amateur stock "day traders" look a lot like Wall Street professionals.
Often, these investors think they are. But that can be a dangerous illusion that could lead to big losses and even psychological problems, trading and behavioral specialists say.
Day Trader's Losses Roiled an Already Volatile Personality
With their powerful computers and software programs, day traders "feel that if they have the mechanical ability to compete with professional market makers, they in fact could become professional market makers," says Robert Koppel, a trading-firm executive and the author of six books about the psychological elements of trading. But "nothing could be further from the truth." Most amateurs can't "clinically distance themselves emotionally from the decisions they make in the market," he adds. "It's very tough."
The once-obscure field of day trading has been thrust into the spotlight by the shooting rampage of Mark O. Barton, the Atlanta day trader who murdered nine people in two brokerage houses last week, as well as his wife and two children, before killing himself. The U.S. Securities and Exchange Commission has requested Mr. Barton's trading records from both brokerage firms, Momentum Securities Inc. and All-Tech Investment Group Inc., someone familiar with the situation said. Last month, closely held day-trading and software firm Tradescape.com agreed to buy Momentum for an undisclosed price.
Even before the killings, day trading had come under close scrutiny from federal and state regulators, who are examining everything from the firms' advertising to their lending practices. And more recently, after the spring's steep correction in Internet stocks, some investors have found it increasingly difficult to make money through day trading, a process that entails moving rapidly in and out of stock positions to capture tiny profits on each trade.
Of course, there is plenty of volatility in the market to interest the quick-finger trading types. But "the correction that's happened since last April cleared out a certain number of day traders," says James Marks, an electronic-commerce analyst at Deutsche Banc Alex. Brown. "I'd be very surprised if some people didn't get wiped out."
It's gotten so difficult some day traders say they've now "reformed." Gary Korn, a 43-year old Tucson, Ariz., lawyer, says he "fell into" day trading last August when he realized he could make a steady profit doing it. Soon, after signing up for a $300-a-month data feed and installing a fast T-1 computer line in his house, he was hooked: Mr. Korn says he often made more than 100 trades a day, most of them in the morning before work.
"It's very addictive," he says.
Mr. Korn recalls how he was nearly mesmerized by the green, yellow, blue and red hues of his professional-style Nasdaq "Level II" stock-quote screen. But Mr. Korn says he "was very stressed out from doing this trading," as he lost track of the bigger issues that can move stocks, such as economic and industry trends. Instead, he just watched what other professional market makers were doing. "You're not researching," he says. "You lose sight of everything."
Last month, realizing his return on day trading was a paltry 2.8% in the first six months of this year, Mr. Korn moved most of his money out of his online-brokerage accounts and into a new account at Merrill Lynch & Co., which offers online trading as well as consultations with a broker. His new broker drew him up a basic financial plan and started to allocate his virtually all-cash portfolio into a diverse stable of stocks and bonds. He even owns General Motors Corp. now, though he concedes he is "bored to tears" by it.
At first, Mr. Korn says he still couldn't fight the urge to make a quick trade. But when he would call his broker to try to sell a stock he had bought earlier in the day, the broker "would very firmly say, 'I thought we were getting away from that,' " Mr. Korn recalls. "It's sort of like Alcoholics Anonymous through Merrill."
Day trading nevertheless has flourished in recent years. Before new Nasdaq Stock Market trading rules went into effect two years ago, most day traders were professionals -- most of them young, and often crammed into dingy trading rooms in Manhattan -- who were able to use fast computers and their own quickness to exploit a technical inefficiency in the market. The new rules cut profits for many professionals but allowed amateurs greater access to the market, mainly by giving their stock orders more prominent display in the Nasdaq system.
So aggressive, entrepreneurial individual investors, also caught up in the more general online-investing trend, began flocking to day trading. The rise of supervolatile Internet stocks, like Yahoo Inc. and Amazon.com Inc. also made it easy to "scalp" small profits on trades, since the stocks whipsawed up and down so quickly. Retirees and housewives showed up at day-trading houses, where they traded their own money over souped-up computers. Others quit their jobs and accessed the markets from home via Internet brokers or software packages. More than half the 2,000-plus customers at All-Tech, for instance, trade away from the firm's offices.
But the practice still represents a tiny part of all investing. Though analysts say there are no industrywide numbers available, less than 1% of online investors qualify as "true" day traders, according to NFO Interactive, a unit of Greenwich, Conn., research firm NFO Worldwide Inc. James Lee, the co-founder of Momentum Securities, has said day traders who do business in trading offices probably don't number more than 5,000, although most rapid-fire traders do their business at home.
An NFO study released last week found that the average day trader makes 130 transactions in a six-month period. That's about 11 times more than the average online investor.
The lure of quick riches can be enticing. And it's often the better educated, more affluent traders who think they can come up with "a strategy, a protocol, a methodology to this day trading that will inoculate them from risk or extreme loss," says James Marlen, a securities lawyer in Dallas.
The Web site for All-Tech, one of the trading firms targeted by Mr. Barton last week, notes that "the amount of money you can lose is directly related to your degree of discipline in following the trading techniques our affiliate, All-Tech Training Group Inc., teaches. If you are disciplined in following the techniques you will be taught, losses can and should be kept to a minimum."
Even the jacket of a popular day-trading book, Marc Friedfertig and George West's "The Electronic Day Trader," seems to promise to hold all the answers. A blurb on the jacket says the tome contains "everything you need -- to get started trading stocks online, to make hundreds or even thousands of dollars in a matter of minutes." Mr. Barton, on his initial application to open an account at Momentum, noted that he had read the book. He also said he had received training from AllTech.
Mr. Friedfertig, a former professional options trader who is now the managing member of day-trading firm Broadway Trading LLC in New York, declined a request for an interview Friday. Instead, he forwarded a letter he had sent to his firm's traders about the Atlanta killings. The missive played down the incident's link to day trading but noted that "rarely does a day go by when Broadway does not communicate with its customers about the challenges of day trading and high risks involved." He even noted that the firm offers counseling through the Village Institute for Psychotherapy, whose director, Frederick Woolverton, says he has received calls from about 10 Broadway traders in the past year or so.
Mr. Woolverton calls Mr. Barton's situation in Atlanta "pretty unusual" and "very dramatic." But "what's not unusual or dramatic is for these people to be under tremendous pressure," he says. "Depression is a big factor that they struggle with." Still, Mr. Woolverton says he's only seen one securities trader that he advised to leave the business.
Mr. Koppel, the author and trading executive, says psychological problems can crop up for day traders not properly trained to handle the wild swings of the markets. "If you're feeling uncertain, the market is going to make you feel even more uncertain. If you have feelings about inadequacy, the market's going to tap into those feelings about inadequacy," he says. Though he believes about 20% of amateur traders can do very well, perhaps even in a bear market, it is difficult for most traders to rationally execute trading strategies when they start to lose money.
Others take a dimmer view. "These people are not investors. They're gamblers," asserts Robert Bontempo, an associate professor of management at Columbia University's business school who was trained as a social psychologist. "Calling this investment is totally missing the point ... It's a casino, and to be surprised when greedy, desperate people lose all their money, and then snap, I mean, who are we kidding? Why should we be surprised by that?"
Indeed, securities regulators have been troubled over the past few months by some day-trading advertising they feel glorifies the trading strategy and doesn't adequately disclose the risks. Other firms may have bigger problems: Texas securities regulators, working with prosecutors, are investigating individuals associated with Momentum Securities for activities connected to trading practices, according to people familiar with the matter.
In a statement, Momentum said it had talked with "senior state securities regulators," as well as "a number of representatives from state attorneys general offices and to the Texas Attorney General's office and have no indication whatsoever that securities regulators are working with those offices."
In a financial report for the fiscal year ended Oct. 31, Momentum stated that "the Texas State Securities Board is conducting an aggressive ongoing review of the Company's business and operations." The report, which was filed with state regulators, added that "to date, no administrative action has been commenced by the State."
David Grauer, director of enforcement for the Texas State Securities Board, said: "I'm not entitled to comment on any ongoing investigative matters."
And over the past several months, the SEC has been conducting an examination of the practices of a large number of day-trading firms, including All-Tech, based in Montvale, N.J., and Momentum, based in Houston. The examinations are focusing on a number of areas, including the disclosures that day-trading firms make to their clients, how the firms supervise trading activity and whether firms are violating margin-lending requirements. If customers borrow excessively "on margin," they have more money to lose, all while trading more and generating more commissions for their brokerage firms.
This month, a task force of state securities regulators will release a report examining the practices of day-trading firms. Among other things, the report will include an analysis of sample day-trading accounts. In an administrative complaint filed last year against Block Trading Inc., a now-defunct day-trading firm, Massachusetts securities regulators alleged that only one of the branch's 68 accounts made money.
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