Mark Ingebretsen
Now that the markets have calmed somewhat, will daytrading become popular again? The question is important not just to daytraders themselves, but to average investors. If the seasoned troops don't feel ready to hit the trenches quite yet, average investors should definitely think twice before trying their extreme strategies.
You know the story, of course. Daytrading peaked in popularity during the late '90s. Back then, you'll recall, share prices of overinflated tech stocks -- especially Internet stocks -- routinely moved by $20 or more in a single day. That presented traders with lots of opportunities, because volatility is the stuff they thrive on. The heady times gave many neophyte daytraders a false sense of confidence. A rising tide lifts all ships, as the saying goes. Meaning: Just about any strategy a daytrader employed appeared to work. Then the crash of 2000 changed everything. Maxed out on margin, their portfolios over-weighted with volatile stocks, many daytraders watched their net worth plummet in tandem with the Nasdaq's 60% decline. "A lot of traders were blown out by the Nasdaq bear market and will never be back," says Scott Slutsky. A former lawyer who is now a daytrader himself, Slutsky co-founded the subscription online daytrading chat room SuperTraders.com with Jim de Porre, a.k.a. Rev. Shark, as he's known on America Online's stock boards. "Now trading is real work," says Slutsky, "and only the best have survived." Exactly how many have survived? Peter Stolcers, a senior vice president with Terra Nova, an online brokerage popular with daytraders, says estimates vary. But he believes that a hardcore group numbering between 100,000 and 120,000 remains. People in this group make 50 or more trades per month, he says. And they include short selling
in their arsenal of tactics. Stolcers and others I spoke with say that in addition to this seasoned group of 100,000 or more, a new breed of daytrader is cautiously entering the markets. So far the evidence for this is largely circumstantial. But it suggests that this new breed of daytrader is more savvy, more realistic in expectations and intent on employing new strategies. Chiseling Profits
"People used to believe they could buy a laptop and make a fortune," says Tim Bourquin, who co-founded the OnlineTradingExpo, which organizes exhibitions for active traders. "People now are much more realistic. We're seeing a lot fewer dentists and plumbers who want to quit their day jobs," he says. Judging from the attendance figures at his shows, Bourquin says interest in daytrading continues to rise, though. Other evidence bears him out. At Datek, another brokerage catering to active traders, the number of accounts grew from about 502,000 to 805,000 between April 2000 and April 2001, a rotten period for the markets. Bourquin believes that the post-crash market has forced many daytraders to give up on "scalping" and other extremely short-term strategies that served them well in the past. Such strategies work by chiseling off tiny profits -- sometimes just pennies a share -- from round-trip trades. In the past, these strategies succeeded because pricey technology stocks often jumped several dollars or more each day. This made it relatively easy to follow a stock's momentum for short periods -- sometimes five minutes or less -- then exit quickly before a reversal occurred. The problem now, however, is that many of these same high-volume stocks are selling in single digits. CMGI(CMGI Quote - Cramer on CMGI - Stock Picks) is perhaps the most extreme example. Shares of the Internet incubator company were trading at more than $300 in January 2000 and moving up or down by $20 or more in a single day. A stock split and the Internet rout have since brought the price down to under $3. When stocks sell at lower prices, their daily moves tend to be measured in pennies instead of dollars, which of course makes it tougher to carve out a decent profit during the regular trading day. (FYI: If you're looking for advice on trading low-cost stocks, don't miss Part I, Part II, and Part III of TSC columnist Ken Wolff's series on the topic.) Some daytraders have discovered a workaround, says Bourquin. Many have become swing traders instead. While daytraders focus on market movement over a single day's time, swing traders look for moves that might play out over a week or more. And they often look for moves of 5% to 10% or more.Single-Stock Traders
Another development that may be making it difficult for short-term traders to carve out intraday profits is decimalization, says Stolcers at Terra Nova. That's because so far the effect of decimalization has been to narrow the spread between the bid and ask prices, according to a recent
Nasdaq report. When stocks were listed in fractional format, a 1/16-point move translated into 6.25 cents per share. If a trader were handling 2,000 shares (a size favored by many scalpers) that 6.25 cents per share would mushroom into a $125 profit, before commissions. With stocks now moving in increments of a
penny or less, that same 2,000-share trade would only yield $20, hardly worth the trouble once commissions were factored in. Stolcers says the narrowing spreads may be inadvertently adding to the ranks of daytraders. The reason: The diminished spreads have cut into profits made by market makers and specialists. These market professionals in essence serve as wholesale brokers by taking the other side of trades by retail investors, including daytraders. Now instead of working for major financial services firms like Fleet Meehan, Merrill Lynch and Goldman Sachs, some of these market makers and their colleagues are opting to go it alone. They may be joined by floor traders who worked at the Pacific Stock Exchange. In May, the 102-year-old exchange shut down its trading floor and converted to an electronic format, a move that affected hundreds of traders. In the course of their jobs, market makers, specialists and floor traders may trade just one stock or its derivative. So naturally, they've become experts in how that stock trades. Many will likely stick with trading a single stock if they take up daytrading, Stolcers believes. And their expertise could give them a formidable advantage in the market. Darwinian rules definitely hold sway when it comes to daytrading. Those with more experience will inevitably prey on the weak. The bottom line is that newcomers to daytrading who lack professional experience likely will find it tougher going. Stolcers believes that despite the risks, newcomers will continue to join the daytrading ranks. "Everyone in the industry has been trying to stick a fork in the daytrading business. But this thing is growing," he says. In the coming months, Stolcers believes freshly minted U.S. daytraders will increasingly be joined by those outside the U.S., particularly from countries in Asia. And as competition toughens, education and training will become increasingly important, he says. How might a resurgence of daytrading -- if it does occur -- affect average investors? There's no easy answer to that question, unfortunately. For example, a lengthy
study done by the General Accounting Office last year reported that "The effects of daytrading on both the individuals who engage in it and the markets as a whole are uncertain." It's possible that over the long term, daytraders add liquidity to the market, which would tend to smooth out prices. However, in the short-term, daytraders can increase volatility. If you're a long-term investor, your best means of coping with that volatility is to thoroughly research a company before you invest and decide what you believe is a fair price to pay for its stock. To avoid getting burned, make your move only when the stock approaches your target price. Short-term volatility shouldn't matter if you have faith in the company and if your time horizon is measured in years. 
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