Day Trading: It's a Brutal World

By Daniel Kadlec

No one knows for sure how many people day trade. But the number is way up from a few years ago, when this bull market kicked into high gear and the Internet began making it easy and cheap to buy and sell stocks. Barton Biggs, an analyst at Morgan Stanley Dean Witter, confirms and bemoans the trend in biting missives to clients about his plumber, who is so busy trading he won't come to fix a leaking pipe. I've written about the guy behind the deli counter leafing through Barron's for that day's stock trade. It's epidemic, and it's alarming.

By some estimates, the number of folks who have quit their job to trade full time at day-trading firms is about 5,000--a relative pittance. But add in those who trade online at home or between meetings at the office, and you may have as many as 5 million. Technology makes it possible; the bull market makes it irresistible.

Yet there's nothing easy about it. Jake Bernstein, author of The Compleat Day Trader, estimates that only 15% of those who take up day trading make much money at it. Many lose big because they don't have the discipline to sell immediately when a stock moves against them, or they leave a lot of money on the table by being too quick to capture profits when a stock starts to move their way. Often mistakes are a result of making overly large bets. "If you have too much at risk, you're prone to acting on emotion," Bernstein says. "And emotional decisions are likely to be bad decisions."

A successful day trader has to be able to stay calm while absorbing painful losses. "It's easy to get suckered into this game," says Ari Kiev, a psychiatrist and trading coach who wrote Trading to Win. "You start to lose, and you try to make it back, but you lose more. You lose the rent money and then the college money. That activates feelings of inadequacy, failure and catastrophe. You start blaming everyone but yourself. It's very destructive." Authorities believe something like that occurred with Mark Barton.

There are about 100 day-trading firms in the U.S. Clients open accounts with minimums of about $50,000 and are allowed to use fully equipped trading posts, which include a telephone; monitors displaying the bid-and-asked-prices of stocks and other data; financial and general news wires; and a direct link to markets where a trader can make dozens or even hundreds of trades in a day. The same tools are generally available at home or in the office via the Internet, though they are less easily managed and access is slower. The day-trading firms make money by taking a commission on each trade. Day traders try to profit from fractional moves in their stocks, and most close out all their positions before each day ends.

It can seem simple when shares are generally rising. Strong markets can mask underlying risks, like losing more than your principal when on margin. Concerned about just that, the National Association of Securities Dealers last week began requiring brokerage firms to disclose day-trading risks and to determine whether a client is suited before opening an account. None too soon. Day traders' favorite stocks have long been Internet and other high-tech companies prized for their big price swings. Since April, Net stocks have fallen on hard times, revealing many formerly brilliant day traders to be little more than lucky novices. Unfamiliar with strategies like selling short or hedging with options, many have lost big and quit. But the flushing out is far from complete.

--By Daniel Kadlec