Day Trading

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DAY TRADING

As one of the new economy's most popular pastimes, day trading generated intense emotions from supporters and detractors alike, and the practice was the source of much controversy. Sometimes referred to with derision as "recreational trading," day trading is a form of stock market activity in which investors, known as day traders, make blitzkrieg runs on several stocks for the purpose of generating very quick gains, but without an eye toward long-term returns. The logic behind day trading holds that the rapid buying and selling of securities in response to very incremental movements can generate quick profits that result in tremendous savings over time.

The practice is premised on the idea of that markets aren't completely efficient. Therefore, small profits can be made by trading in expectation of tiny, incremental movements in stock. Day traders move in to capitalize on the market's corrections. Repeated often enough, these small transactions can escalate into hefty profits by the end of a day's trading, at which point day traders generally liquidate their entire portfolios. Since companies may issue announcements and company news after a day's trading has closed, day traders don't generally want to hold onto stocks overnight, since their line of work entails making split-second buy and sell orders before others can beat them to it.

Day trading requires a nose for minute stock movements, keen trend-spotting skills, and a ready mouse-click. However, professional day traders also rely on tools like sophisticated analysis software and charting programs and a steady stream of financial news. Many online financial portals and content sites feature real-time stock quotes, and some provide charting and chart-customization services. Some electronic trading systems are capable of performing what are known as basket trades, in which several hundred securities are bought and sold in a single transaction. These systems were tailor-made for the day-trading world, in which traders frequently buy and sell thousands of stocks in a single day, and were particularly useful for the big, end-of-the-day liquidations.

DAY TRADING'S ROLLER-COASTER RIDE

Day trading, in its present form, got its start in the early 1990s, according to Institutional Investor, when a New Yorker named Harvey Houtkin began monitoring the delays between breaking news events and the adjustment of prices by certain dealers. Using the Nasdaq's Small Order Execution System, Houtkin made a name for himself by exploiting those delays to make a profit. By doing so, he opened the flood-gates to hordes of new independent traders making connections to exchanges. In addition, these activities engendered the momentum that would evolve into the e-brokerage boom and the emergence of new trading media like electronic communications networks (ECNs).

Day trading made a splash in the late 1990s as the U.S. bull market seemed to defy gravity and news accounts lauded the new economy. Additionally, the Internet opened new lines of business and gave birth to the dot-com stock craze while also lowering the costs of trading. All of these factors enticed new entrants into the field of stock trading. In order to compete with the traditional Nasdaq market makers without paying hefty, profit-reducing fees, day traders began to create their own electronic trading networks, such as Island ECN, to provide a space for buyers and sellers to trade and share real-time market information. As day trading grew more mainstream, the major online trading houses increasingly assumed the capabilities of the larger brokerages. They developed the technological means to simultaneously scan several securities markets, locate the best prices on given securities, and then purchase them instantaneously.

The day-trading binge was cradled by the can't-miss buzz surrounding dot-com stocks in the late 1990s. Paradoxically, this was a buzz that day trading helped to sustain. The most sensational stories told of middle-level office workers making millions by trading on their lunch breaks, or quitting their jobs to trade full time and retire at age 30.

In all, however, the hype surrounding day trading tended to inflate individuals' expectations, often to drastic effects. While there was, indeed, no shortage of success stories, they were in fact an unrepresentative sample. The North American Securities Administrators Association (NASAA) reported in 1999 that 77 percent of all day traders wound up losing money, while the average profit of the winners was a mere $22,000 over a period of eight months. This was a far cry from the instant-success stories in which mechanics were able to retire after a few months' trading. The dizziness of the cultural phenomenon reached its most harrowing moment in July 1999, when a distraught day trader, having lost some $100,000, murdered his wife and children before wandering into two Atlanta day-trading offices—at which he had placed orders—with a gun, killing nine workers and himself. This horrifying event greatly exacerbated the growing backlash against day trading.

Day trading emerged as a fear among employers as well. With more and more workers secluded in offices or cubicles with their own computers and Internet access, the temptation to engage in day trading on company time was a source of growing concern. To stave off such slacking, companies resorted to installing Universal Resource Locator (URL)-filtering software on company machines, designed to lock employees out of selected sites or domain names.

Day trading eventually became nearly synonymous with the high-stakes excesses of the glorified bull market, while emerging as one of the primary forces driving the market's wild volatility in the late 1990s and early 2000s. On the other hand, it also was indicative of the wider democratization of the once exclusive world of Wall Street trading, and enhanced the market populism that became such a central part of U.S. culture in this period. In 2000, the NASAA reported that a whopping 7.5 million Americans maintained 7.5 million online brokerage accounts, while the Electronic Traders Association estimated between 5,000 and 10,000 investors placed orders through specialty day-trading houses.

Following the dot-com and tech-market bust in spring 2000, day trading was widely seen as a passing fad, and in large part the novelty was just that. But day trading never went away completely and by 2001 the practice was not only still alive but, by some estimates, healthier than ever, according to Fortune. While the field underwent a shakeout similar to that of the dot-com economy, meaning that the casual part-timers were largely forced out of the field, the ranks of professional day traders stabilized at about 50,000 nationwide. Bear Stearns reported that, while the market registered a 37-percent decline in 2000 in the volume of trading by occasional day traders—those making 15 to 40 transactions annually—day trading as a whole increased its volume by 55 percent.

As of 2001, the future of some major online brokerages looked murky. This especially was true for those firms, such as Ameritrade and E*Trade, for which occasional trading constituted the cornerstone of their business. Such firms poured vast sums into marketing in the early 2000s in efforts to maintain the footholds they'd acquired, and were likewise seeking to branch out in order to stay afloat, diversifying away from an increasingly risky market.

Day trading washed up on European shores several years after it dominated American business headlines. However, with it came the lessons of the American phenomenon. As a result, day trading was expected to take hold more slowly and more subtly than it had in the United States.

THE IMPACT OF DAY TRADING

Day trading brought mounds of new money into the market. Moreover, this was money managed not by the traditional blue-chip investors or fund managers, but those looking to enter and exit a market quickly with only a short-term gain in mind. As a result, day trading was largely responsible for the wild dayto-day fluctuations in stock markets, particularly the Nasdaq, in the late 1990s and early 2000s. In effect, day trading altered the traditional theories about how markets work by dramatically boosting the degree of market volatility and transforming perceptions of risk exposure.

Among professional money managers, day trading was widely perceived as a form of gambling engaged in by uninformed amateurs. Still, this didn't always lead to calls for the abandonment of the practice. Gregory J. Millman, writing in the investment journal Barron's, compared day traders to a swarm of maggots, insisting that, while they may be loathsome, day traders do a good job of eating away at the market's "diseased tissue," those "inefficiencies that slow and sicken markets."

Such statements, though harboring much of the animosity still felt by traditional investment analysts, nevertheless reflect the general sentiment prevailing in the early 2000s that day-trading's existence was more or less accepted. Whatever one's feelings about the practice, day trading grew into such a force that, by the 2000s, investors of all stripes had little choice but to take day trading seriously, as its effects couldn't be denied. More positively, it was a growing source of income.