C A P I T A L I S T P I G
Their Day In The Sun
May 18, 1999 - 4:30 PM
By Jonathan Hoenig
Simply put, online trading has exploded. According to some estimates, up to 15% of the Nasdaq trading volume is generated by day traders. The number of online accounts has grown 138% since September 1997, and by the end of the year online brokerage accounts will account for about a quarter of all retail stock trades. This incredible growth comes from an industry that largely didn't exist until the mid 1990s. "Day traders have had a powerful effect," I was told by Erik Gustafson, the celebrated portfolio manager at Stein Roe. "It has led to increased volume and volatility, especially in Internet [stocks]."
The parabolic growth of online trading is matched only by the meteoric rise of the Internet stocks themselves. In recent months, names like America Online (AOL), Yahoo (YHOO) or (cough) CMGI (CMGI), have been tearing up the stock charts, moving 10%, 15% or even 20% in a day. While these stocks trade with enormous volume - several million shares a day - much of the activity comes from the smallest of small fries, small "retail" investors trading a few hundred shares per clip over their computers. Mutual funds are too mild for these mavericks. They are playing individual stocks, and only a fully funded E*trade (EGRP) account will satiate their need for speed.
You've seen the commercials, smirky storylines that are both fantastical and familiar. In one memorable ad, a teenage boy is disciplined by his stereotypically suburban parents for blowing off curfew. His punishment? No online trading for a week and no tooling around in the military helicopter he supposedly purchased with his million-dollar stock-trading treasure chest. The inference is anything but subtle - open an online brokerage account, turn on CNBC and download your way towards a Forbes-like fortune. Even if your trading experience starts and ends with a mint 1996 Ken Griffy Jr baseball card, the commercials suggest that almost anybody can point and click their way to Cozumel.
It was advertisements of this ilk that prompted Securities and Exchange Commission Chairman Arthur Levitt to sternly reprimand the finance industry for its misleading depiction of Wall Street's ways. "In a market environment where many investors are susceptible to quixotic euphoria, I'm worried these commercials step over the line and border on irresponsibility," Levitt remarked at a recent press conference.
I agree, and so do other professionals.
"I wouldn't recommend it to anyone", cautions Gustafson. "You are playing against professionals who have more resources than you. You are betting against the house and will ultimately lose the game."
Let's lay down some lexicon. The concept of online investing is still largely misunderstood, even among the legions of young people who are often attributed with spearheading its growth. Technically, online investing refers to the use of an electronic, usually Web-based interface for entering orders to buy and sell stocks. Instead of calling your broker, you simply call up a Web page. Both nervous newcomers and professional prognosticators appreciate the speed of execution, access to information, and relative anonymity that online trading affords.
But online trading has come to be synonymous with day trading, the hyperactive and heroin-flavored practice of jumping in and out of equities like a beefed up Ben Johnson. Day trading means literally buying and selling a stock on the same day, hoping to capture as little as a 1/16 profit from a stock's intraday fluctuations. The reward gets downright dangerous, especially on 10,000 shares of a stock which can't be sold short on a downtick.
While over a long period of time a company's underlying economic fundamentals are the primary determinant of its stock price, from moment to moment the market more closely resembles a mosh pit. Over the short term, stock prices are largely a function of supply and demand. If demand for a particular stock shoots up, so will its stock price, regardless of any fundamental change in a company's potential for profit. Day traders are merely hoping to ride those trends, often taking large positions in companies about which they know nothing. To a day trader, Microsoft's (MSFT) tradition of product innovation or revenue growth is moot. Over holding periods often measured in minutes, all that matters is that Mr. Softy is on the move. Are you going to jump in or miss it?
Sound dangerous? It is. From Milken to the Menendez brothers, history suggests that opting for the quick buck is a road better left untraveled.
"Historically, going back to both in the 1920s and 1960s, [rising stock prices] have created a similar casino mentality to what we see now," said Haywood Kelly of Morningstar StockInvestor. "But the online interface is accessible to everybody, especially younger people. It's so easy to trade and it's also very addictive." His advice? If you want to day trade, treat it like gambling - the money you use to retire on should be invested in a mutual fund or long-term stock holding.
The Monte Carlo metaphor has been echoed by many longtime pros who have seen precious metals, biotechs and even Beanie Babies have their day in the speculative sun. And while nobody doubts the long-term potential of the Internet, don't get tempted to think stock prices can only go up. Market insiders liken today's enthusiastic Internet exuberance to the tulip bubble of 17th century Holland, when the wealthy so coveted the newly imported flower that the price of one bulb soared to the equivalent of $2,250 contemporary U.S. dollars. More recently, stock buzz drove an issue called Presstek (PRST) from $4.93 in April 1994 to $97.37 in May 1996. Now, with the sugar high of speculation over, the shares trade back down near $5. An excellent "overview of excess" can be found in a smart little book called Extraordinarily Popular Delusions and the Madness of Crowds, by Charles MacKay.
"Is investing gambling or is gambling investing," asks regular Capitalist Pig guest Joe Silich of Morgan Stanley Dean Witter, who steers his high-net-worth clients away from day trading. "Over 90% of a return comes from making the proper asset allocation, while only 1.8% comes from market timing. If you are getting a high off making a trade, then I don't think you should be trading in the first place."
My advice is that when it comes to stocks, don't plan on buying during Squawk Box and selling after Street Signs. You'll most likely end up “churning” your account into chum, wasting precious trading capital on commissions and the spread (the difference between the bid and ask prices of a security). If you crave the adrenaline rush of a high-stakes poker game, I suggest you bring $100 down to the Silver Cherokee casino and put some Native American's grandkids through college.
You want to take chunks, not ticks, out of the market. So when it comes to stocks, better to become a position trader, someone who researches and executes orders online but holds positions for a number of days or even weeks. You catch bigger moves, and bigger moves mean bigger money.
But you can't just buy a security and hope things will turn out okay. That's gambling. Traders who last awhile know why they are getting into a particular trade, and know exactly when and where they are getting out. What you're looking for is a catalyst, some piece of information that will affect the company's prospects but hasn't yet been factored into the stock price. That is where the Net really shines. Entering an order electronically is nothing compared with the ability to tap worldwide databases of data.
When it comes to actually loading your weapon, I'd take a faster server or better service over lower commissions any day. Competition has prompted online commissions - or the price to play - to plummet. Since the mid-1990s, the average cost of an online stock trade has dropped from about $50 per trade to the single digits. The sales literature from one online broker, Brown & Co., likens their $5-per-trade rate to a tip. Just a little something to leave on the table, right? Not exactly. Assuming about 250 trading days a year, pulling the trigger even twice a day will cost you more than $2,500 in commissions. That's not a tip, it's a trip. And in first class, no doubt.
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