Daytrading Clarified
Recently, daytraders have gotten a lot of press because of the tragic events last week at All-Tech Trading and Momentum Securities in Atlanta, Georgia, where Mark Barton shot 22 people, killing 9 of them. The media has reported that he lost $105,000 in eight weeks, although this figure does not include Barton's losses at All-Tech, which has not yet released his financial records. But while the press has focused extensively on the deeply tragic aspects of this story, they have done little to clarify the type of daytrading that Barton was involved with. Here is an explanation of the different types of daytrading.
Broadly Used Term
The term "daytraders" has become widely used, and now covers many types of activities. When we talk about daytraders at Briefing.com, we are usually loosely referring to two types of daytraders: internet traders, and daytrading firm traders.
Internet Daytraders
The internet, and its low cost of trading, has generated a large subculture of independent daytraders. Daytrading in the internet often simply means people who are buying and selling a single stock in a single day. For example, someone who places a single BUY order in the morning, and closes the position with a SELL order later in the day, can very rightfully call themselves a daytrader.
But this type of daytrading is very different from the type that Mark Barton was doing at two separate daytrading firms.
Daytrading Firms
Daytrading firms such as Momentum Securities and All-Tech Trading, make possible a very different type of daytrading, based on the idea of exploiting very small inefficiencies in market pricing.
Daytrading firms take advantage of how the Nasdaq system works in order to provide an individual with the same type of purchasing power as a market maker. To understand this, you first need to understand how the Nasdaq system works at Level 1 and Level 2.
Nasdaq Levels
Level 1 is the level at which most people trade stocks. When you request a quote, what you see is the most recent transaction. You do not see what the current bid or ask price is, nor can you see what type of limit orders are waiting "in the queue" to be executed. When you place an order at Level 1, your order is transmitted to a broker, who operates at Level 2.
All internet online trading brokerages are Level 1 Nasdaq systems.
Level 2 is the level at which actual transactions occur. Although there are services which provide Level 2 quotes over the internet, there are no services that provide Level 2 transaction capability over the internet. To make a transaction at Level 2, you must have a Level 2 Nasdaq terminal, which can only be purchased directly from Nasdaq.
The Level 2 transaction terminal allows a market maker to not only see orders "in queue" but to actually make a transaction. When a "market order" appears on a Level 2 terminal a market maker can purchase securities at the Bid prices, and immediately Sell them at the Ask price. This spread between the prices is profit to the market maker, in exchange for his willingness to purchase securities to create liquidity.
What the daytrading firms have done is build Level 2 transaction systems within their firms in order to enable their clients to make transactions at Level 2. These are not internet based systems.
To use the services of the daytrading firms you have to go to their offices and use a terminal system there. Although some firms will connect a system from their office into your own home, the cost is usually very expensive.
Stealing Market Orders at Level 2
The basic concept behind daytrading is that the systems enables one to "steal" market orders from the market makers by being quicker on the "mouse click" than they are. Most of the systems we have seen allow complete fulfillment of a BUY or SELL order simply by clicking on a market order that appears on the screen.
By setting an immediate BUY order (adjusting the bid in 1/64 increments with the up-arrow key) in between the existing spread shown on the screen a daytrader can execute the other half of a market sell order by having a BUY order appear instantly higher than the existing BID. The Nasdaq system then gives this market order to the daytrader.
Having secured this inside-the-spread order, the daytrader then tries to sell it immediately at, or lower than, the presumably higher Ask price, posted by someone else. We say presumably because it may have changed in the short time period since the buy, or even in reaction to the daytrader's buy.
Harder Than It Looks
It would seem that the ability to buy and sell stock in between the spread would guarantee profits. But two things make it more difficult than at first glance. Transactions costs make it necessary to operate at high volume orders. But, market shifts make it hard to move large volumes at a single price.
Transaction costs are generally $25 or higher at daytrading firms, but often include a per-share fee of $0.01 to $0.005. In order to break even with a 1/8 spread, a minimum of 400 shares must be turned over. For a 1/16 spread, more than 800 shares must be sold. This is just to recover the transaction costs.
To make money requires a much higher share volume. For example, buying 1000 shares at $8 with a $25 fee costs $8025. To sell this at $8 1/8 brings a profit of just $65 (including a half-cent per-share fee). But the market price also needs to remain stable, or rising, in order to unload all 1,000 shares at $8 1/8.
Of course, the daytrading firm systems can also be used to place ordinary limit orders just as other investors do. But this is like using a shotgun to swat flies.
Daytrading Firm Requirements
To open an account at a daytrading firm generally requires substantial assets. Here are typical requirements for most daytrading firms, without being specific to any one firm.
Minimum amount to open: $50,000 to $100,000
All positions must either be closed at the end of the day, or reduced to specified concentrations, typically 1,000 to 2,000 shares maximum in any one stock (rules for overnight positions vary by firm: some firms limit intra-day concentration of shares as well)
Margin available: Generally 33%; the maintenance margin amount applies, because the margin position is not held overnight. This gives a daytrader 3-1 buying power. $300,000 worth of marginable stock can be purchased with $100,000 cash. Margin requirements also vary by firm, and may be more restrictive for smaller accounts.
No interest paid on cash in the account.
A requirement that positions be closed overnight can be onerous if the market has turned against someone in the course of the day. The loss must be taken or additional cash deposited to meet overnight margin requirements.
Very Different From Investing
Even this brief description of daytrading firm activity should make it clear that trading at a daytrading firm requires a totally different approach to the stock market than investing. It is also very different from internet "daytrading." Because daytraders generally close positions at the end of each day, a daily timeframe is all that is appropriate. Researching the long term prospects for a company simply isn't necessary.
Appropriateness
Internet daytrading is enjoyed by many individuals, and every day we get emails at Briefing.com from people who have done well in a single day's trade. But daytrading at a daytrading firm requires a very different personality that few people are suited for, especially on a long term basis.
Although many well established Wall Street firms have traders that play essentially the same role as daytraders, the individuals typically do not make careers out of it. It is position that one passes through, as part of an overall education on the market. The high degree of concentration and stress that a daytrader at a Wall Street firm goes through is usually simply too much to sustain for more than a couple of years.
Tragic Consequences
The stress also was clearly too much for Mark Barton. Although it is likely that Barton's problems were more extensive than just his trading losses, the stress of the trading appears to have been the precipitating event for his murderous acts.
Momentum Securities closed his account on Tuesday of last week because it had fallen below the minimum equity required, due to losses. Later that day, Barton killed his wife. On Wednesday Momentum closed his account because the $50,000 check Barton had deposited bounced. Later that same day he murdered his own children. The following day he promised to deposit $200,000 in his account, but then went and murdered nine and wounded 13 other people at Momentum and All-Tech Trading.
Obviously there are people who have the right personality mix for daytrading, especially at the more casual level permitted by online trading. But daytrading at a daytrading firm is simply not for everyone.
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