The Securities and Exchange Commission (SEC) defines day trading as follows: "Day traders rapidly buy and sell stocks throughout the day in the hope that their stocks will continue climbing or falling in value for the seconds to minutes they own the stock, allowing them to lock in quick profits. Day trading is extremely risky and can result in substantial financial losses in a very short period of time."
In its investigation of the practice, which arose in its most modern form with the Internet, the U.S. Senate Permanent Subcommittee on Investigations defined day trading as "placing multiple buy and sell orders for securities and holding positions for a very short period of time, usually minutes or a few hours, but rarely longer than a day. Day traders seek profits in small increments from momentary fluctuations in stock prices after paying commissions." In the more technical language of the National Association of Securities Dealers (NASD), day trading is "an overall trading strategy characterized by the regular transmission by a customer of intra-day orders to effect both purchase and sale transactions in the same security or securities."
Canada and the World magazine, in an article titled "Rolling the dice," saw analogies to day trading in the "bucket shops" of the 1920s. "They were storefront businesses where traders gathered to buy and sell stocks. Many were illegal and not unlike off-track bettering shops. Customers were doing no more than placing a bet on whether certain stocks would rise or fall. In the Roaring Twenties, just about everyone could score in a bucket shop. Buy your stock, any stock, in the morning; by evening you could be confident you could sell it at a profit." Most of the bucket shops, according to the magazine, disappeared in the stock market crash of 1929—only to resurface as Internet-based day trading programs in the bull market of the 1990s. As air rushed out of that bubble, day trading almost collapsed. With the market strengthening again in the mid-2000s, market analysts, here and there, see day trading reviving again.
DAY TRADING AS GAMBLING
Ever since the emergence of stock and currency markets in the 16th and 17th centuries in Europe, an element of chance has been a strong component of trading in stock so that, around the world's stock exchanges, the movement of stock prices, up and down, has become the main focus of traders' attention and the original (and still central) goal of selling stock—namely raising capital for a business—is mentioned only in the context of "prudent" investing for the "long term."
As Larry Williams pointed out in an article on day trading in Futures, today's markets still behave as they always have. What has changed, above all, is volatility and speed. "Virtually every day-trading system offered for sale for the last 30 years," Williams wrote, "hasnot been a hard and tight mechanical system…. So, if you what you want is a fail-safe purely mechanical system, I'd suggest you turn your attention to real estate investing or bank accounts." [Emphasis added.]
Day trading differs radically from "prudent investment" in that it is based on very brief movements in the price of stocks. These movements are exploited (or attempted to be exploited) in the most modern form of day trading by using very rapid communications techniques provided by the Internet. Stock is not held for any length of time at all. The transactions are based on watching one or many trend lines conveyed to the trader's screen electronically. Buying and selling is based on a pattern of change. Actual information about the company whose stock is bought or sold is therefore less important than any kind of rumor, be it true or false, which will change that pattern for a few minutes or hours. For these very reasons, day trading is more akin to gambling than investment. Not surprisingly, promoters of day trading and those claiming expertise in it emphasize techniques of trading all of which have the flavor of "systems" used in gambling, e.g., counting cards or statistically evaluating the frequency of black or red on the roulette wheel—and knowing when to hold or fold.
WINNERS AND LOSERS
Statistical data on the performance of day traders are largely anecdotal, but the conclusion is that most people lose money, some in a spectacular way. Canada and the World magazine cited one such spectacular case, that of Mark Barton. "He lost hundreds of thousands of dollars day trading in an Atlanta branch of the All-Tech Investment Group. Shortly after that, in July 1999, he walked into the All-Tech offices and shot and killed nine people."
One comprehensive study of day trading was conducted by four scholars (Brad Barber, Yi-Tsung Lee, Yu-Jane Liu, and Terrance Odean) focusing on the Taiwanese stock exchange. They studied 130,000 day traders over a five-year period, 1995 to 1999. Barber et. al. discovered that most day trading is done by a few. "About one percent of individual investors account for half of day trading and one forth of total trading by individual investors." Do these heavy traders make a lot of money? The authors go on: "Heavy day traders earn gross profits, but their profits are not sufficient to cover transaction costs. Moreover, in the typical six month period, more than eight out of ten [actually 82 percent] of day traders lose money." Only a tiny handful, according to the authors, made a strong return. It is worth noting that the period of the authors' study coincided with an expanding market.
ELECTRONIC DAY TRADING
Day trading in its current form has its origins in the birth of the computerized, over-the-counter NASD, which occurred in 1971. Fourteen years later, NASD created the Small-Order Execution System (SOES). SOES made it easy for individuals to execute stock trades automatically so long as the orders were for 1,000 shares or less. Trades placed through SOES bypassed the phone lines used to make most trades and placed orders in a matter of seconds, instead of minutes. While SOES users may not buy or sell the same stock during a five-minute period, there were still a group of daring investors who thought they could use SOES to make rapid stock transactions to make a great deal of money. Thus day trading was born.
The modern day trader is no longer limited to SOES. Indeed, the most popular tool for the day trader today is electronic communication networks, or ECNs; they are internal networks set up to handle groups of customers who make large blocks of stock trades. All the members of one ECN may trade directly with other members of their network, placing buy or sell orders electronically. This has become the main tool of the day trader. To best use that tool, day traders watch the NASDAQ Level II screen religiously on their computers. The best bid on any given stock is displayed on the NASDAQ Level I screen, while the Level II screen displays all bid prices for a selected stock. This increased amount of information allows the trader better to gauge what is happening with the stock: What are the high and low bids? How many bids have been made? Are the number of bids increasing or decreasing? This information is invaluable as the day trader decides which stock to buy.
With the growth of any money-making activity come the hangers-on—true for day trading as well. Book and newsletter publishers, authors, commentators, and consultant stand ready to share their wisdom with the would-be day trader. Anyone tempted to participate in this activity might, however, begin by carefully reading what the SEC see has to say on the subject at its Web site, http://www.sec.gov/answers/daytrading.htm.
Anuff, Joey, and Gary Wolf. Dumb Money: Adventures of a Day Trader. Random, 2000.
Barber, Brad and Yi-Tsung Lee, Yu-Jane Liu, and Terrance Odean. "Do Individual Day Traders Make Money? Evidence from Taiwan." Social Science Research Network. Available from http://papers.ssrn.com/sol3/papers.cfm?abstractid=529063. January 2005.
Barker, Robert. "Day Trading: It's Not Always A Fool's Game." Business Week. 16 August 2005.
Bresiger, Gregory. "The Return of The Day Trader: But Is Another Disaster Around the Corner?" Traders. 1 February 2004.
Catton, Grant. "NASD Seen Moving Toward Limiting Day Trading." Compliance Reporter. 31 May 2004.
"Credit Extension/Day Trading Requirements." Notice to Members. National Association of Security Dealers (NASD). May 2004.
D'Souza, Patricia. "Day Trader's Blues." Canadian Business. 16 October 2000.
Kitchens, Susan and Michael K. Ozanian. "Last Man Standing." Forbes. 23 May 2005.
Maiello, Michael. "Day Trading Eldorado." Forbes. 12 June 2000.
McGinn, Daniel. "Do-It-Yourself Isn't Dead Yet: Day trading was all the rage during the bull run. But even with stocks falling, many are still at it, and adding new recruits. Just don't call them 'day traders' now." Newsweek. 3 February 2003.
"Rolling the dice." Canada and the World Backgrounder. May 2003.
Schwartz, Nelson D. "Meet The New Market Makers: They're Young, They're Rich, and They Couldn't Care Less about Graham & Dodd. But They're the Ones Driving Those Insane Tech Stocks, and They're Not Going Away." Fortune. 21 February 2000.
U.S. Securities and Exchange Commission. "Day Trading." Available from http://www.sec.gov/answers/daytrading.htm. January 2005.
U.S. Securities and Exchange Commission. "Day Trading: Your Dollars at Risk." Available from http://www.sec.gov/answers/daytrading.htm. 20 April 2005.
U.S. Senate Permanent Subcommittee on Investigations. "Day Trading: Everyone Gambles but the House." 24 February 2000.
Williams, Larry. "Day-Trading modern markets." Futures. 15 September 2001.