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INNOVATION
& DESIGN Home Page Architecture Brand Equity Auto Design Game Room SMALLBIZ Smart Answers Success Stories Today's Tip INVESTING Investing: Europe Annual Reports BW 50 S&P Picks & Pans Stock Screeners Free S&P Stock Report SCOREBOARDS Hot Growth 100 Mutual Funds Info Tech 100 S&P 500 B-SCHOOLS Undergrad Programs MBA Blogs MBA Profiles MBA Rankings Who's Hiring Grads | | MAY 23, 2001 STREET WISE By Amey Stone The Darwinism of Day Trading Wall Street's chill has made starry-eyed amateurs an endangered species, ceding the game to the strong, the brave, and the experienced
All such evidence to the contrary, the day-trading industry is alive and well. The down markets have shaken out day-trading novices, who either lost their money or were scared away. This dynamic has hurt many of the online brokerages, which have seen their most active trading base turn cool. In contrast, however, the ranks of true day traders -- the people who trade in and out of stocks, sometimes hundreds of times a day, as their full-time gig -- has stayed fairly constant. While there has certainly been attrition (there always is in this business), the dropouts have been replaced by more experienced traders, often Wall Street emigrées, who are trading more than ever, executives at day-trading firms report. SWEET SPOT. "We're getting fewer in number, but the people we're getting are more sophisticated and trade more," says Ron Shear, president of Carlin Equities. Many of them are using short-selling strategies to profit when stocks fall in price -- something novice traders don't like to do and can get wiped out attempting. "We're in the sweet spot of the active-trader market," says Greg Ferris, president of CyberTrader, which was acquired last year by Charles Schwab. His firm claims 400% growth in 2000 over 1999 levels. April brought the strongest account growth in the past year, he says. Analysts who study the industry back up the firms' claims. Day-trading volume has surged 55% the past year even as the number of day traders held steady at around 50,000, according to a Bear Stearns report. At the same time, trading volume of so-called active investors has fallen sharply from an average of 25 trades a year in 1999 to an average 16 a year in 2000. At the end of 2000, the most active, or semi-professional group of day traders made up 81% of online trading volume, up from 76% at the end of 1999, Bear Stearns found. "Wall Street was just blindsided by the continuing growth in the sector," says Omar Amanat, chief executive and founder of Tradescape Corp. "No one was expecting it." On May 22, his firm made up 18% of the volume in trading of Emulex (EMLX ) and 21% of the volume of Qlogic (QLGC ). There is no evidence that the trading increases volatility (although traders are drawn to volatile stocks), but there are some indications that investors benefit from day trading since it helps keep markets liquid, says Amanat. MAINSTREAM. Lured by sophisticated trading technology that promises better execution, more mainstream investors with slightly longer time horizons (they actually hold trades overnight) are opening accounts at day-trading firms. "We've gotten a lot of investors that are not day traders per se," says Bobby Earthman, president and founder of Tradecast, which was acquired earlier this year by Ameritrade. A mid-May report from market researcher Celent Communications also found that day-trading firms are swimming upstream and attracting customers among hedge funds and smaller investment management firms. The mainstream securities industry, which once dismissed the day-trading craze, has clearly taken notice. Leading online discount brokerages like Charles Schwab and Ameritrade are incorporating the day-trading firms' sophisticated order-routing technology into their offerings. Merrill Lynch and Goldman Sachs have also recently bought market makers that allow them to give their clients direct access to the markets, a must for day trading aficionados. "The newer technology adds a competitive differentiator," which firms need to keep customers, says Fritz McCormick, the Celent analyst who prepared the report. The availability of sophisticated trading technology to sole operators may be encouraging more professional traders to go out on their own. That's because the move to trade stocks in decimals combined with lighter trading volume overall has crimped profits at Wall Street's market making firms, which means traders take home less money. That has driven many to try trading for their own account, where they get to keep all the profits, says Craig Howard, who heads up the sales division at ProTrader Group. Decimilization may also be leading to more day-trading volume for another reason: Since stocks are traded in penny increments, traders now need to take on the risk of bigger trades to profit from smaller price moves, says Amanat. OVERSEAS EXPANSION. Also attracting more experienced traders is the fact that there are more securities available to be traded over the high speed "direct-access" systems day traders use, including foreign currencies and derivatives, says McCormick. Firms are expanding overseas, which is drawing many Asians and Europeans into the day-trading market. While major Wall Street brokerage firms are getting into the day-trading business, anecdotal evidence suggests that the more fly-by-night day-trading operations that pulled in novice investors off the street are closing shop. Shear says he's relieved that many such firms, which made money by offering pricey courses that promised an easy path to riches, are gone. "They gave the whole industry a bad name and I'm glad they've faded away," he says. Also helping the industry's image are new regulations. Two new rules that went into effect in October require day-trading firms to do a better job of determining if traders' strategies are "appropriate." In other words, they are required to learn whether new customers have enough money that they can afford to lose some of it, and also if they have some investing experience. New regulations that go into effect in September raise the minimum equity requirement for high-risk margin accounts, which allow trading on borrowed money, to $25,000 from just $2,000. NO SHORTCUTS. "It's safe to say the firms are doing a better job of disclosing the risks," says Marc Beauchamp, executive director of the North American Securities Administrators Assn., which found in an August, 1999, study that only 11% of day traders broke even or made any money. "Since April of 2000 [when the market began to tank] there are fewer people thinking day trading is a short cut to Easy Street," he says. Still, regulators are skeptical that day trading has really raised its profile. "I've noticed some improvement," says Barry Goldsmith, executive vice-president of enforcement at the National Association of Securities Dealers' regulatory arm. But he still thinks plenty of day traders are probably losing their shirts. "I don't think it's any more or less risky than it was during the up market," he says. "People still need to be very careful." Celent's McCormick agrees there is no evidence that the people doing it are making more money. "Whether their net worth is going up, at least they aren't fleeing," he says. While some of the more sophisticated investors are lifting the day-trading industry, the greater good is that fewer novices are trying it. "There was a mentality created in the bull market that anybody could open up an account, throw some dollars at the market, and make a living," says Keith Savitz, chief executive of online data site B4Utrade.com. "Now people realize that day trading takes some skills." Clearly many investors are now taking a more serious approach. "Online investing is not going away," says Savitz. "However, people have definitely wised up."  Stone is an associate editor of BusinessWeek Online and covers the markets in our daily Street Wise column. Questions or comments? 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