Day Trading

Day traders took a hit last week when the North American Securities Administrators Association (NASAA) filed a report resulting from a seven-month investigation into this highly speculative stock market activity. Their report accused day trading firms of misleading their investor customers with promises of quick riches, failure to supervise their operations, and the making of improper loans to customers to keep them trading.

The only difference between these practices and those of the gambling casinos is that the casinos follow better truth-in-advertising practices. Casino billboards that advertise slot machine payoff percentages like "97.5%" are up front about their offer to give you 97.5 cents for every dollar you give their machines. Think about it and you can now understand why big, lavish hotels surround casinos!

Thanks to the technology of the Internet and advances in computer and communication capabilities, day trading has become the "fix du jour" for those gambleholics who believe they can get rich quick by buying and selling particular stocks many times a day. Their methodology hinges not on the fundamentals or any other criteria used by rational investors. They are simply betting on price movements, up and down, hoping to make a few dollars many times by moving in and out of the market.

The analysis provided in the report suggests that they are not too successful: 70% of the customers at one major day trading firm lost money! Only 11.5% of traders demonstrated the ability to do profitable short-term trading.

If that isn't sobering enough, consider what the report called the "annualized cost/equity ratio." This calculation measures the amount of profit required on average equity just to pay transaction costs and break even. That ratio-an astonishing 56%! That means that a speculator starting with $100,000 account would have to earn $56,000 just to cover his costs!

Who gets the $56k? The 62 day trading firms operating with 287 offices around the country, catering to roughly 4,000 to 5,000 traders; that's who. These firms provide their trader customers with fancy computers and high-speed hookups to trading networks and charge commissions for each trade.

The traders, many of whom have abandoned their regular jobs, are distinct from the 5 million or so amateur investors who occasionally trade on the Internet at home or at work.

None other than Joseph E. Granville, noted market prognosticator, was quoted in Barron's last week saying, "History has shown that it sometimes takes only one event to prick a market bubble. That may have taken place in Atlanta on the afternoon of July 29 when a disappointed day trader walked into two brokerage offices and shot and killed 12 people before committing suicide. Murders do not end a bull market, but it was reference to day trading and the fact that the trader had lost $505,000 since April which focused attention on day trading at a particularly sensitive time while the market was taking a dive. That, in our opinion, was enough to break the current continuity of bullish opinion."

Risk will always be a fact of life for investors. The NASAA report clearly underscores the higher levels of risk involved in day trading. We should stick to buying and holding the stocks of the best companies in the market. And if we need a bit of risk, we should climb a mountain. Better odds!

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