Daytraders or Daydreamers? Separating the Successful From the Wannabes

Recent events have shown that daytrading isn't a cakewalk. Here's a look at why.
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It looks as if daytrading has come full circle.

Three years ago it was an arcane, risky, sometimes lucrative game played by a handful of street-smart "bandits." Then the media discovered these regular guys with rock-star incomes. Before you could say "margin call," every third person you met was calling himself a daytrader.

This pretty much guaranteed the kind of multistage meltdown that's now under way.

First, Massachusetts accuses several daytrading firms of false advertising and shuts down their in-state branches. Then a trader cracks under the weight of his losses and shoots up the Atlanta office of daytrading giant

All-Tech

. Then, on Aug. 9, a study by the

North American Securities Administrators Association

concludes that only 11% of All-Tech traders make money consistently. Meanwhile, the fourth horseman of this apocalypse -- arbitrary government regulation -- is kicking up dust on the horizon.

Now, hopefully daytrading will revert to its natural state as a specialty of the serious few.

And yet some of you (OK, some of us) still have a secret wish to chuck it all and trade our way to freedom. So this might be a good time to look at what separates that successful 11% from the wannabes and never-weres.

Let's start by defining daytrading. As the name implies, it involves going in and out of stocks fairly quickly, trying to catch small moves. Positions are generally closed down at the end of each day.

According to the NASAA study, there are 4,000 to 5,000 people trading through specialized daytrading brokerage houses, doing, on average, 35 trades a day. Another 200,000 or so make two or three trades a day through online brokers such as

Charles Schwab

(SCH)

and

E*Trade

(EGRP)

.

Yet few of the first group, and even fewer of the second, make consistent money. Why? Because unlike investing, where over long periods of time economic growth allows everyone to win, trading is a zero-sum game. Every good trade is someone else's bad trade. Since the core of the market is made up of veteran daytraders and Wall Street market makers (traders who have agreed to "make a market" by buying and selling a given stock and who stay in business by doing more good trades than bad), the odds are unfavorable from the start.

The guys who beat the odds do so by treating daytrading as a profession rather than a hobby. They get good training, both in the classroom and on the job. And they accept that there are dues to be paid, in both time and money.

A while back, to see how the classroom side of this works, I sat in on a training seminar at the New York headquarters of

Broadway Trading

, a high-profile daytrading firm. The 40 or so attendees had each paid $1,500 for what many of them saw as a chance at easy money.

They quickly found out otherwise.

After a morning spent slogging through hard, technical worksheets and sitting at practice terminals that simulated real-world trading scenarios, we listened as Broadway traders stood up and told, not tales of riches, but of start-up losses: "I was

a colander of cash. ... I dropped $60,000 before I made a dime. ... The question isn't whether you'll lose money at first. You will. The question is whether you'll have enough left when you finally learn to still make a living."

Next up was Marc Friedfertig, co-founder of Broadway and co-author (both with George West) of

The Electronic Day Trader

, the bestseller in the field.

"Hi," he said, and pointed to the middle of the room. "What's your name? Bob. Bob what? How am I going to learn your names if you don't wear your nametags? So Bob, you're trading a stock, you're willing to pay 50 1/8.

Goldman's

been selling all day long and is on the offer at 50 1/4. Do you SOES it, preference Goldman with a 50 1/8 bid, or bid through

Island

? What would you do?"

Bob hesitates, and hands go up all over the room. Someone picks the right answer and justifies it, and Friedfertig moves on to other scenarios.

I soon stop taking notes. My last entry is, "If you have a market order and

Merrill Lynch

is on the offer, and somebody takes Merrill ahead of you and lifts the level and there's an ECN on the offer including Island, you'll get kicked out. You guys understand that?"

The point of these hard-to-follow examples should be pretty clear: Serious daytrading is more than just entering market orders through Schwab. And the people who master this stuff are the ones who win.

As the seminar winds down, Friedfertig compliments the people in the class on how far they've come in a week. But don't, he cautions, think you're daytraders. That will take months of watching, listening, making mistakes and losing money. The total cost of the process might equal the tuition at a top MBA program.

Next week -- if you're still interested -- I'll get specific, with a look at the strategies (mental and market) that let the best daytraders make millions.

John Rubino, a former equity and bond analyst, writes a column on mutual funds for POV and is a frequent contributor to Individual Investor, Your Money and Consumers Digest. His first book, Main Street, Not Wall Street, was published by William Morrow in 1998. At time of publication, he had no position in any stocks mentioned. While Rubino cannot provide investment advice or recommendations, he invites your feedback at

rubinoja@yahoo.com.

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