Extreme Wall Street

day traders play the market like a video game. it's dangerous but you can get rich

I Remember Sitting in a hotel ballroom in early 1993, when the Dow Jones industrial average was at about 3000, listening as the manager of one of America's largest mutual funds shocked his audience by announcing: "Dow 10,000 by the year 2000." Nobody believed him. The general feeling among his polite questioners seemed to be that he had taken leave of his senses. Stocks more than tripling in seven years? No way. As it turned out, he was just about right on the money. But not even that visionary saw that the market was about to become a national obsession. Who would have believed that millions of Americans who had never watched so much as a soap opera would become passionate fans of CNBC, watching nothing but stock market news from morning till night? Who could have predicted the impact of the Internet? Even Bill Gates was late seeing that one.

In the Nineties, the volume of stocks traded on the New York Stock Exchange and the Nasdaq market has more than quadrupled, from a few hundred million shares a day to nearly 2 billion--and occasionally more. It used to be that anyone who wanted to trade a stock called his broker and paid a commission steep enough to discourage even adventurous souls. Then came discount brokers. Next came the Internet. Now anyone can sit at home and click a mouse and buy and sell IBM or Microsoft for a commission that amounts to lunch money.

And that was just the prelude to the next great wave: day trading. Using sophisticated software leased for a few hundred dollars a month, some brave (or foolhardy) pioneers (estimates range from a few thousand to tens of thousands) are now linked electronically into the same computer systems used by the giant brokerages on Wall Street. Day traders compete directly with the so-called market makers for the quick profits to be made as stocks blip up and down. Forget investing. For day traders, as an ad on CNBC says, "an hour and a half is the long term." Ideally, they're out of stocks altogether before the market closes, ready to start fresh the next morning. Hence the title day trader. Holding a stock, any stock, overnight is a definite no-no. As one of them says, "Don't ever let a trade turn into an investment."

What follows is the account of one guy in his 30s who started day trading just after it all began, about three years ago. Steve Poulter worked as a television reporter on the East Coast after college. Then he realized that network stardom was going to require years of paying dues in small towns he didn't want to live in, so he moved home to Salt Lake City. He switched to day trading after a couple of years as a successful stockbroker. He's been doing it ever since, living a quietly comfortable life as he builds his trading bankroll. By now Poulter regards himself as an old-timer in a new business, and says that he's committed to it as a career. Here is Steve's story:

My first rule is that I'm showered and dressed before I sit down in front of my computer, because if I roll out of bed and go online half awake in my T-shirt and shorts, I'm just asking to get hammered. I assure you that the professionals who are making markets in stocks at Goldman Sachs and Merrill Lynch aren't sitting there half asleep in their T-shirts and shorts. They're dressed for business. If I want to compete with them, I have to take it as seriously as they do.

So I'm dressed and at my workstation about 45 minutes before the market opens. My monitor is set up in front of a TV, so I can watch them both at the same time. I sit in a comfortable chair. If I walked you into the room where I work, you'd think you were in an office. I won't even bring in coffee or juice. Spilling that on my keyboard in the middle of a trade is the last thing I need. I eat away from where I work.

I turn on CNBC and CNN to see what happened overnight in the Asian markets and what's going on domestically. I check out a few websites to gather information (the one I use most is Briefing.com), to see which stocks are splitting, that sort of stuff. I use Silicon Investor (www.siliconinvestor.com) for news about tech stocks. Then I go into the day trader chat rooms to see which stocks people are talking about. Day traders are a tight-knit group.

There are good and bad chat rooms. In the bad ones people are hyping mostly junky stocks that sell for $1 or $2. If you try to hype anything in the good chat rooms, they will kick you out. Most of the good ones offer a free introductory service, but if you want to get into the heavier stuff, you have to subscribe. I see what the other day traders are doing, and that's important, because their trading action influences the price of stocks. They're plugged into all sorts of news sources, and as soon as they get news, they post it. That puts you a few minutes ahead of most people--and a few minutes is all you need.

If you live in the Midwest or on the West Coast, you could trade for an hour before you go to work. That's a good deal, because if you can hold a job while you're learning, it takes a lot of pressure off your trading.

There are about 50 stocks that day traders track. The stocks that are driving this craze of day trading are the same companies that make it possible for us to do this: Cisco, Dell, Microsoft, Compaq, 3Com, Yahoo, Sun Micro and Internet stocks. All the usual suspects. Day trading exists because of their beautiful new technology. Who ever thought that a guy could live anywhere in the world and be hooked right into the market alongside the Merrill Lynch trading desks on Wall Street? I have a friend who day trades from his ranch near Devil's Tower in Wyoming and another one who sits on the back porch of his mansion making trades on his laptop. He said a while ago that this damned day trading was getting in the way of his golf game.

Just before the market opens, I check my e-mail. It comes from--how can I say this?--a damned guru. A fat buddha. Even day traders have gurus. But this one's good. He gets up even earlier than I do and studies even more news sources. Finally, I check out which stocks the market makers are looking to buy, which ones they want to sell and how they're tinkering with prices in the moments before the market opens to the public.

I'm seeing this on a Level II screen. I use the software from Maverick Trading in Salt Lake and run my trades through them. Level II gives me access to Nasdaq-only information--live, streaming data--that you never see if you go online with a discount broker such as Schwab or E-Trade. They work fine for what they do, but they're just showing you a bid price and an ask price--Microsoft is at 1491/2 at 1495/8. They're not showing you how many market makers want to buy or sell how many shares of a specific stock. If I see 50 market makers trying to sell Microsoft at 150, that tells me it's going to be tough for Microsoft to go higher than 150 right now. There's resistance at that price. If a lot of market makers are offering to buy Microsoft at 149, it's going to be tough for it to go below that. There's support at that price. Day trading is about learning to spot those small, likely movements in price--and trading them to your advantage. If you want to move in and out of stocks fast, you need Level II software. If you don't have the information the market makers have, then day trading is a gamble that the house always wins. If you (continued on page 118)Day Traders(continued from page 70) have it and learn how to interpret it, you'll see some of the same clues the market makers see about which way prices are likely to move during the next few seconds or minutes.

When the market opens, I know the three or four stocks that provide my best opportunities, but then I have to sit on my hands. I don't want to buy or sell a stock short at the opening. That's when the market makers are filling all the orders that have flowed in overnight from brokers around the world. That price movement tells you what investors are doing. The opening is for investors, not day traders. The buying pressure from those orders may be enough to move a stock up for five minutes, but after the orders are filled, the stock may sag. I don't want to take my shot until I know what I'm shooting at. If I commit at the open and I'm wrong, it hurts. Investors won't even notice. They bought the stock and they'll hold the stock. Big deal what happens in the first five minutes. But for a day trader there's nothing more painful than a loss first thing in the morning, because then you're not even trying to get ahead, you're trying to catch up.

I'll wait until I see which way the market is going and which stock has the most buying or selling pressure. I'll wait until my heart and mind give me the signal: This is the stock and this is the moment to buy it. I'll set my limit price, what I'm willing to pay. I always buy at limit, because if I enter a market order, I'm at the market maker's mercy. I want to pay my price, not his.

Once I make my decision, I click the mouse. Instantly! Fill out your order! Press the button! The best traders move in milliseconds. If I want a stock, I don't hesitate. If it's going up, I want to own it now. If it's going down, I want to sell it short now. I'm playing the momentum. I don't care about the company's future. I don't care about its next earnings report. I don't even care if the stock's going to be up next week. I care about whether it's going to be up in the next three minutes.

It ticks up a quarter point or half a point, and I'm getting ready to sell because I don't know how long that momentum is going to last. The Level II screen shows me who's buying and selling how much and gives me a minute-by-minute chart of the stock's movement that day. After a while, you learn how to read your feelings. A lot of it goes against what we've heard all our lives. I don't want to buy at the lowest possible price. If I think a stock is about to move up, I want to see it start before I buy. I don't want to be the first one at the party. I want to catch the momentum after it's already begun.

Once I enter my trade, I get my confirmation in about two seconds. That's the key difference between day traders and the millions of people who are just trading stocks online. They may buy on Monday and sell on Wednesday or next month, if it takes the stock that long to go up. I call that position trading. They may not get their confirmations for several minutes. That wouldn't work for a day trader, because he might not want to hold the stock that long. If I buy a stock at the same moment that a regular person--not a day trader--buys it from his discount broker, there's a good chance I'll have sold it before he knows for sure that he bought it.

Most people lose at day trading. I've seen dozens of day traders come and go. I have seen people lose $5000 or $10,000 in their first few days and then decide they don't want to do it anymore. And I made the same mistakes everyone else makes. I lost money at first, but I didn't get blown out, because I'm bullheaded. I was determined to make a lot of money in this life, so I stayed around long enough to learn from my mistakes. I think you need a minimum of $25,000 trading capital to start--preferably $50,000. And the success rate is going up. People are getting some time under their belts using the software. The teaching is better. There are some good books on how to use these powerful new tools.

How can you tell if you might qualify as a day trader? Can you stand losing some of your money before you learn how to make money? Can you stand not making a lot of money when you begin? When I started, my two major goals were not to try to get rich quick and not to lose everything. When I teach people how to day trade, I always tell them that their goal as a beginner is not to make money; it's to learn how not to lose money. If I want to sit down in my T-shirt and shorts and outsmart the market for $900,000 and retire next year, I figure my odds are about one in a million. I have had some spectacularly good days. Yahoo went my way once, for about $3500 in a matter of minutes. But that was a combination of luck and timing; it was one trade, one day. I didn't outsmart the market, even though that's the kind of glossy story you might read in the press. I don't believe those articles about day traders who start out making $600,000 a year. I say, send me their tax returns. If you want to start off making $10,000 one day and losing $5000 the next day, go to Vegas.

Did you see the movie Rounders? It's about professional poker players--a home-run hitter, and the flashy guy, who doesn't last long. But there was another character who said, "I've got a mortgage, I've got child support, I'm just here to earn a living." And he did. They called him a grinder. Well, I'm a grinder. That's the attitude you have to have if you want to stay in the game. If I'm a surgeon, I'm not going to get rich and retire next year. Why would I expect to do that as a day trader? I'm up against the smartest people, with the best training, the best information and the best technology.

But I can make a good living and be my own man as a day trader, as long as I don't try to do too much. I'm just going to buy--or sell short--one stock, and I'm going to be correct about that one stock. Or I'll cut my loss before it hurts. Then I'll buy another stock and be correct again. I don't try to be a mutual fund, buying 40 stocks at once. I just stick to making small, quick profits. But I had to learn how to make $100 a day, after commissions, before I could learn how to make $200 a day.

I know day traders who swing bigger sticks than I do. I've seen some make $50,000 in one day. They bought a few thousand shares of lower-priced stocks--$8 to $12 a share--and rode them up a few bucks each and sold them. The rule is: Let your winners run and cut your losses. I'm still learning about letting my winners run. That's an art form, knowing when to take your profit. I've left tens of thousands of dollars on the table, and I'm not talking about difficult profits; I mean easy money. I'd picked the right stock and it was going my way, and I just covered my position too soon.

But the most successful day traders aren't the ones who are best at picking winners. I know a lot who are good at that. The most successful traders are (continued on page 150)Day Traders(continued from page 118) fastest at getting rid of their losers. The cardinal rule of day trading is: Cut your losses. If a trade goes against you, get out. Fast. It sounds simple, but it's the most difficult part. I've learned the hard way. The Internet stock Excite went against me one day for $100. But my ego got involved and I wouldn't admit I'd made a mistake. In a heartbeat, I was down $1500. I finally pulled the plug a few minutes later with a loss of $2000.

Those damned Internet stocks are scary. It's a new industry, so they're going to be volatile, and when you add day traders, you get these huge swings. The day traders are aggressive about Internet stocks. They know the future of commerce is on the Internet, because they're on the Internet themselves. They see its power every day. So when CNBC says it looks like Internet stocks are going to run that morning (which means there's going to be a lot of volume) or that Yahoo or Amazon.com or America Online is announcing positive news (which will bring up the whole sector), then I'll try to make some money. I won't buck the trend.

I'll pick up Excite, for instance, as soon as I dare, and I'll know in advance how much I want to make. Even if it looks like it's going to run rampant, I won't get greedy. I buy 1000 shares, I'm up $1 a share, I'll sell into strength. That's $1000. There are day traders who will go for a lot more, but I've been around long enough to know that $1000 a day is $250,000 a year. On those days when Internet stocks are up $20 or $30, not many day traders take the entire ride. Or even most of it. It's too dangerous. They'll take bits and pieces of it. I bought Yahoo once, sold it a few seconds later down $1, and two minutes later it was up $3 and I'd been panicked out of it. But I keep trading Internet stocks because of the profit potential. You buy Yahoo at the right moment, you're up $5 in two minutes. It's pure adrenaline. But you have to keep a cool head.

There's a guy in Chicago who's the best trader I've ever seen. Why? Because he has mastered the most difficult thing of all: emotional control. There's no emotion in his decisions. No ego. God, that's tough. But he'll sit there with four monitors, like a damned machine, pushing a button and making 60 to 80 trades a day, and even his good friends won't know if he's up $40,000 or down $30,000. You won't see this guy high-fiving after he takes a quick $7 a share out of some Internet stock. You won't even know he did it. He can turn on a dime faster than anyone I have ever seen. Wrong? OK. Click. Next. He's made a small fortune from admitting his mistakes. He buys a stock, it goes down, he'll turn around and sell it short--click, click--and he's gone from a bad trade to riding a profit.

I also watched a good trader blow himself out because he was determined to prove he was right. On one trade! He shorted 2000 shares of Dell at about $75 and it went his way for a quick $4000 profit. But he wouldn't cover. He got greedy. Dell turned up and suddenly he had a loss. He was too stubborn to let go now, so he stayed in overnight. Big mistake. Dell kept going up; he kept holding. He wouldn't admit he was wrong. He eventually covered at about $108. He turned a $4000 gain into a $74,000 loss. Adios. That was painful to watch.

So, is day trading just a crazy Internet boom? No. It's here to stay--even if the market crashes. Maybe that would scare people away, cut the volume. But it won't stop day traders. What happens to a day trader in a crash? Nothing. Day trading is my liberation from fear of a crash. That's for investors to worry about. If I have done what I'm supposed to do and go home at night (well, I'm already home) holding no stock, then the market heading south the next morning is an even greater opportunity for me. Why? Because the market goes down a lot faster than it goes up. Fear beats greed. Every time. So I can short the market. I care less about the market's direction, up or down, than I do about how much it moves. What counts for a day trader is volatility.

Market makers blame us for the incredible volatility now, and there's some truth in that. We're so aggressive playing the momentum in either direction that a stock can move up or down $5 or $10 in a day--and it's still the same stock. No news. The underlying value remains the same. We make life more difficult for market makers. They hate us. They call us bandits. They say we're going to wreck everything for everybody with all this volatility. We'll drive stock prices too high, then drive them down into a crash. Nonsense. We have as much right to buy and sell stocks as they do. What we're really wrecking is their easy profits. They now have to work harder--and smarter--for their money.

Where do I go from here? I've started an e-mail service for new day traders. I'm always looking for a larger account than my own to trade, and I'd like to pair off with a rich investor. That's happening a lot between good traders and wealthy people who are too busy to trade for themselves but want to participate in the action. They want more return with more excitement, so they bankroll a young trader with a good record and then split the profits. I even know of stockbrokers who have left their firms to day trade for their former clients. That kind of action used to be the private preserve of the very rich. No longer.

Those millions of people who are now trading stocks online are eyeing their next step. A lot of them will try day trading and some will stay with it. That's great, because they'll show that this is a legitimate way to make a living. If I had never heard of day trading, I'd still be happy as a stockbroker. I was making a good living. But no way am I going back. Even the New York Stock Exchange is catching up with us. They're talking about opening from 5:30 A.M. until midnight. I can just see millions of people sitting at home after dinner with nothing to do: "Hey, honey, let's jump online and trade a few stocks." Talk about an explosion in volume! Ron Insana on CNBC got it right. He said, "If you like day trading, you'll love night trading."

He covered at about $108. He turned a $4000 gain into a $74,000 loss. Adios. That was painful to watch.

I keep trading Internet stocks. Buy Yahoo at the right moment, you're up $5 in two minutes.