Enter At Your Own Risk:
the Profession of Day Trading
“Abandon All Hope, Ye Who Enter Here!"
If the NASAA (North American Securities Administrators Association) had its way, the infamous script written upon the summit of the Gates of Hell in Dante’s Inferno would be posted above the front door of every day trading office in America.
As Virgil cautions Dante “the souls misery doom’d,” SEC Chairman Arthur Levitt has repeatedly warned the public against the dire consequences of entering the “profession” of day trading. Tony Oz, author of the best selling day trading book on amazaon.com, Stock Trading Wizard, Oz argues that in a democracy individuals have a choice to trade as they wish. “You don’t let them (day traders) take the risk? How un-American is that? They surely can’t stop anyone over 21 from going to Vegas,” he stated in a recent interview.
Along with the SEC and NASAA, since December of 1998 the U.S. Senate Permanent SubCommittee on Investigations (PSI), NADSR (the regulatory arm of Nasdaq), and several individual states have all either initiated investigations, issued scathing reports and/or filed charges of securities violations against the day trading industry.
Undergoing substantial scrutiny, the industry is barely learning to walk. It was not until January 1997 that two events gave these “individual investing” pioneers a jump-start. That month the SEC imposed sweeping changes on the organization of financial markets, providing individuals with improved control over the purchase of securities. Secondly, Inc. Magazine’s report on how day trading firms like Block Trading (now defunct) were giving the average Joe a way to compete mano-á-mano with professional Wall Street traders, inspired a flurry of entries into this emerging market.
Three years later on February 24th and 25th of this year, PSI held the second of two hearings on day trading within a period of six months. Defenders of the trade like Harvey Houtkin, CEO and founder of All-Tech Investment Group (Montvale, NJ) cried foul play, and accused regulators of conducting a “witch hunt.” Known as the “Bad Boy” day trading to his detractors and as “The Godfather of Electronic Trading” amongst friends, Houtkin considers the synchronization of the recent lawsuit brought against his firm by the SEC and the related hearings as a “baseless and conspired orchestration of intimidation.” “It’s a sham. They do this every time. We will vigorously fight the charges. We haven’t done anything wrong,” he recently stated.
Within the short time frame of three years the day trading industry has grown by leaps and bounds. Although estimates vary widely from 40 to 100, the most reliable assessment finds 63-67 firms offering day trading in the US, with a total of 287 branch offices. Roughly 10% of these conduct 80% of the business, being that almost half consists of only one home office with no branch offices.
Firm revenues have grown equally fast. PSI found that 16 of the largest firms grew 276% between 1997 and 1999, pulling in $541.5 million in revenue in 1999, with net profits of more than $66 million.
The Electronic Traders Association (ETA), which claims to represent the day trading industry with 16 member firms, estimates that 4,000-5,000 people day trade full-time, making 150,000-200,000 trades a day, representing 12-15% of Nasdaq volume. However, contrary to these numbers gathered via an “informal survey,” PSI reported that 15 firms alone opened more than 12,000 new accounts last year. The discrepancy is attributed to bad record keeping and a deliberate attempt to dilute the highly publicized client attrition rate and respective loss of tens of thousands of dollars per person.
Investigative reports from PSI, the SEC, NASDR, Washington State Security Division, and NASAA all concluded on average that over 75% of individuals lose all their initial investment while day trading. Washington found that customers lost an average of $36,000, the highest reported loss being $641,000.
Such devastating losses were frequently reported last year, the most prominent one being the $500,000 lost by Mark Barton prior to his murderous rampage from July 27-29 in Atlanta, GA, killing 12 people including his wife, two children, eight day traders and himself.
The industry itself often admits that these losses are fairly standard. Oliver Velez, CEO of Pristine.com and the keynote speaker at the Online Trading Expo held in New York in February of this year proselytized:
“Let me just say this, I am very, very appreciative that we have losing traders. We need losing traders, so that we have winning traders (laughter)…Losing traders are probably here to stay. What is even more disturbing…is that we have found about 85% of individuals who try their hand at the markets actually fail within six months. Equally disturbing is the fact that of those individuals who make it beyond six months about 50% of those are gone, eliminated, knocked out, wiped out within 12 months. It’s an undeniable fact the odds are against anyone who tries their hand at his for a living.”
Several critics argue agree that these great losses are due to the simple fact that the odds are against anyone engaging in this risky business, quite likeresulting in a consistent comparison to gambling.
Senator Max Cleland, D-Ga. exclaimed at the most recent Senate hearings “You get better odds in Las Vegas. This is not just roulette, its Russian roulette.” Peter Hildreth, Director of Securities Regulation, New Hampshire Bureau of Securities and President of NASAA, also made the same analogy in his Senate testimony six months earlier stating, “Firms that essentially say, ‘Hey, come on down…we’ll sell you a training course and you can sit in front of our computers and you’ll get rich.’ This is hucksterism. The odds are you won’t get rich; the odds are you will lose all money with which you trade. The fact is day trading isn’t investing, it’s gambling. There is not other word for it.”
Tony Oz thinks there is. Author of the best selling day trading book on amazaon.com, Stock Trading Wizard, Oz argues that in a democracy individuals have a choice to trade as they wish. “You don’t let them (day traders) take the risk? How un-American is that? They surely can’t stop anyone over 21 from going to Vegas,” he stated in a recent interview.
However, after calculating the average costs, losses and gains of the day trader it is difficult to not be swayed by the regulators’ conclusions. The PSI found that a day trader’s average commission cost is $16 per trade and that he makes 29 trades a day. This means the average day trader needs to make $110,000 a year in stock market gains simply to “pay the rent.” In essence, day traders spend most of their time and capital simply trying to break even, due to the exorbitant running tab of trading commission fees.
The greatest losses however often result from margin lending. Under current regulations, a trader can double the money he uses to trade simply by borrowing from the firm or fellow traders “on margin.” PSI found “day trading firms systematically arrange for customers who cannot satisfy margin calls to obtain from other customers short term loans at high interest rates.” The NASAA discovered the usurious interest rates of margin call loans to be on average .1% for an overnight loan, or 36.5% on an annualized basis.
Examples of such exorbitant lending practices abound. PSI found that Momentum Securities (Houston, TX) used one customer’s account to lend almost $10 million to 52 customers in a single month, with the margin loans often exceeding $100,000. The SEC also recently charged that throughout 1998, All-Tech Direct was responsible for making 103 unsecured loans to customers to meet margin calls totaling more than $3.6 million, enabling these customers to meet margin calls and continue trading when the balance in their accounts fell below required levels. Since firms primarily make their money from commission charges, it is always in their interest to have a client continue trading and to trade frequently.
Despite the statistics, the increasing number of individuals foolishly losing their life savings, and the unrelenting examination of regulators, the day trading industry continues to evolve, outpacing all obstacles. Faced with charges of potentially criminal behavior and the passing of pending regulations aiming to curtail trader’s losses, several firms and companies forming the supporting cottage industry have taken more conservative approaches to attracting new customers. Exaggerated claims of great gains to be had have been wiped clean of their web sites, substituting them with risk disclosures. The sullied term “day trading” is being diluted by new words like “active trading,” “short term trading,” “hyper active trading,” “swing trading,” and “momentum trading.” And firms are changing their names for a fresh start.
In addition, some of the traditional brokerages are beginning to take notice. Leading on-line brokerage Charles Schwab’s $488 million purchase of day trading firm Cybercorp in early February caused several heads to turn in the financial world. According to Information Week, the purchase is part of Schwab’s strategy to increase cash flow. For even though day traders are a small minority of the 7.5 million investors with on-line accounts today, they account for almost half of all online trading revenue due to the frequency and volume of their trading.
Moreover, as the sold-out crowd of 3,500 attendees at the recent Online Trading tradeshow attests, there remain thousands of people willing to roll the dice for a price, hoping to win big by day trading.
Copyright © 2000
Lorenzo D. Domínguez. All Rights Reserved.
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