Report Slams Day Trading for Risk, Abuse
The vast majority of individual investors who “day trade” stocks lose money, and the day-trading industry is rife with widespread abuses such as deceptive advertising, illegal loan schemes and improper bookkeeping, according to a study released Monday by state securities regulators.
In a sampling of traders at one firm, the report by the North American Securities Administrators Assn. found that seven of 10 lost money and that only slightly more than one in 10 had demonstrated an “ability” to trade successfully.
The study repeats many of the charges that state regulators have lodged against day-trading brokerages over the last year, as the popularity of such rapid-fire, high-risk trading has surged among small investors.
Even so, the report is expected to put further pressure on the controversial industry. It comes less than two weeks after day trader Mark O. Barton went on a lethal shooting spree at two Atlanta day-trading firms where he was a customer--and had racked up large losses.
The report paints a picture of an industry that seeks to lure newcomers with misleading claims of profit potential. The firms earn money by offering training programs and charging commissions on each trade clients execute.
To keep the commissions coming, some firms arrange for customers with losses to borrow money to keep trading, the report said.
“It seems that too many of the firms in the day-trading industry suffer from poor compliance [with securities laws] and lax supervision,” said David Shellenberger, a Massachusetts securities regulator and the lead author of the report.
Using specialized computers, day traders try to profit by darting in and out of stocks dozens or even hundreds of times a day. The goal is to accumulate small profits on many trades each day.
An estimated 5,000 individuals trade out of boutique brokerage offices nationwide. Thousands of others work out of their homes.
Day trading has been termed a bull-market phenomenon that has attracted scores of people who are no longer satisfied with steadily but slowly building profits through buy-and-hold investing.
Yet regulators worry that day-trading firms underplay the risks involved and that most investors lose large sums.
“There is a difference between telling a prospective customer he may lose his money versus telling him he will probably lose all his money,” Shellenberger said.
The Securities and Exchange Commission has been conducting on-site examinations of day-trading firms for potential improprieties. And the National Assn. of Securities Dealers, the brokerage industry’s self-regulatory organization, recently proposed that day-trading firms be required to extensively screen potential customers to ensure that they’re suited to the tension-filled trading style.
Day-trading firms roundly criticized the NASAA study, saying it exaggerates and draws conclusions based on scant evidence.
“The NASAA people have hyped this as being a problem beyond any recognition,” said Saul Cohen, an attorney representing the Electronic Traders Assn., a day-trading industry group.
NASAA’s analysis of customer profitability covered 26 traders in the Watertown, Mass., office of All-Tech Investment Group over a 10-month period in 1997 and 1998. The average tenure of each trader was four months.
The report showed that 18 of the 26 traders lost money in the period, with the total exceeding $675,000. Of the eight people who made money (totaling $420,000), several were profitable solely because of a single winning trade. And the most successful trader “had limited short-term trades and no day trading,” the report said, indicating that the profits stemmed from longer-term investing.
Day-trading firms said the study was far too small to form a true picture.
“We’ve got thousands of accounts and he looks at [26], and that’s supposed to be a representative sample?” said Linda Lerner, All-Tech’s general counsel. “It’s a piece of trash.”
Day-trading firms acknowledge that most customers lose money in their first few months of trading but say profitability increases with experience.
Data supplied by two firms suggest that 55% to 60% of people lose an average of $8,000 in their first five months of trading, said day-trading attorney Cohen. After five months, about two-thirds make $25,000 to $30,000 a month while others lose $6,000 to $8,000 a month, Cohen added.
The study by NASAA, which comprises securities regulators from many state governments, also alleged that day-trading firms undertake questionable lending schemes designed to keep money-losing customers trading as long as possible.
When customers using borrowed money face “margin calls” requiring them to put up more cash to cover paper losses, some firms arrange for them to receive loans from other traders, a practice that may violate the law, the report said.
Such lending “appears to be so prevalent that it may be an integral part” of day trading, NASAA said.
Day-trading firms counter that customers lend each other money to help friends avoid the trouble of having to temporarily wire money into their accounts.
