Sunday, June 20, 2004

A Fool and His Money are Soon Parted

Some people are constitutionally incapable of learning from history. The day traders are back.

EIGHT rows of men sit facing north, shunning the morning sun in favor of watching the pulsing computer monitors lined up, three to a man, in front of them. Occasionally, the hush is broken by the thump of a fist and a muttered profanity.

These men are not video game fanatics. They are day traders, at work one recent morning at the Fifth Avenue office of the Schonfeld Group.

Day traders, that species of investor who tries to profit from short-term movements in stock prices over a few days, hours or even minutes, were a fixture in the city in the late 90's. But when the market tanked, their dreams of riding the soaring Nasdaq to a life of affluence - preferably on their own private island in the Caribbean - vanished. Chastened, they went back to their jobs as construction workers, teachers, pharmacists and mail carriers.

Now they have returned. Although the number of day traders is nowhere near what it was at the height of the dot-com bubble, defectors have gradually started to return, thanks to the relative strength of the market over the last 18 months.

[............]

With the renewed interest comes the individual spirit of these "active" traders, a term many of them prefer so as to distance themselves from the excesses of the 90's.

"What is risk in life?" asked Gene Bonnano, who worked for I.B.M. for 22 years before becoming a full-time trader three years ago. "Working for Enron and having your pension taken away? Working for a big corporation like I did and not being able to spend time with your family?"

[............]

Critics say such trading is basically gambling; on its Web site, the Securities and Exchange Commission warns investors, "Day trading is extremely risky and can result in substantial financial losses in a very short period of time."

Parts of the industry have been rife with abuses, and some have been the targets of legal actions by the government. But, in addition to offering the independence that day traders typically desire, advocates say day trading is safer than long-term investing and is an easy field to enter. All someone really needs to start is a chunk of cash, time and a willingness to learn.
That highlighted sentence is the proof in the pudding that those who engage in day-trading must suffer from a dismal combination of madness and stupidity; according to what financial theory has "buy and hold" ever been a more dangerous investment strategy than day trading?

The reality of stock picking is that most "active" traders will do worse in the long term than anyone who, conscious of his ignorance, simply plumps for an index fund, and not just because they aren't the Warren Buffett clones they'd like to imagine themselves to be: for one thing, each trade one makes generates brokerage fees that serve to raise the returns one needs to simply break even, and the big funds have the financial muscle to get much better terms than Joe Average ever will.*

Anyone who engages in day-trading as anything other than a sophisticated form of gambling for pleasure is quite simply a fool. Those who'd like more information about the right and wrong ways to go about investing than can be provided in a blog post could do worse than check out Burton G. Malkiel's "A Random Walk Down Wall Street"; it won't promise to make you an insta-millionaire, but then again, it isn't likely to lose you your life's savings in a few afternoons either.

*Even so, most mutual funds would also be better off with a "buy and hold" approach that simply consists of replicating the portfolio of some popular stock index, as Malkiel clearly points out. Stock picking is a fool's game, and the only reason it's popular with Wall Street hustlers is that they need people churning their portfolios to generate fat brokerage fees.

UPDATE: This old Slate article ought to be of interest. In particular, the following tidbit ought to initiate a few doubts in the minds of those who still think day trading might be a good idea.
Most estimates suggest that 80 to 90 percent of all day traders lose money. And that's in absolute terms: These people leave their day trading careers with less money than they had when they started. Those statistics say nothing about how many day traders lose money in relative terms, which is to say underperform the S&P 500. (If you do worse than an index fund, you're effectively losing money, because you can invest in an index fund with no labor or opportunity cost at all.) It's probably safe to say that less than 5 percent of day traders are successful, even without considering the opportunity cost of all the time and energy they have to put into their trading. (emphasis added)
An honest pitch for day-trading would be "Lose Money Fast!"