The Heyday of the Individual Trader

In politics, 1998 was the year of impeachment. In sports, it was the year of the great home run race. In the stock market, it was the year of the individual trader.

In search of large--and immediate--profits, small investors traded stocks last year in a fashion once reserved for Wall Street professionals.

That’s not to say that old-style buy-and-hold investing is dead. In fact, experts credit individual investors’ long-term investment habits, especially through mutual funds, with preventing the summer market downturn from becoming more severe or longer-lasting.

But driven by super-low commission rates and a volatile stock market that seemed tailor-made for short-term action, small investors appear to have dramatically stepped up their trading of individual stocks in 1998.

“There’s been this tremendous swell of trading as opposed to longer-term investing,” said David Brown, chief executive of Telescan Inc., which runs the WallStreetCity Web site.

As the traders’ ranks grow, so do the questions about the long-run effect on the market--or at least on the stocks individuals target. Will daily price swings become even more exaggerated? Does the U.S. market become less a capital-raising arena for legitimate companies and more a glorified gambling hall?

For now, what’s clear is that many more Americans have gotten the trading bug over the last year. That’s best shown by the growth of online discount brokerage firms that cater specifically to small investors.

Online Firms Report Surge in Trading

At Ameritrade Holding Corp., for example, the number of accounts at Sept. 30 was up 212%, to 306,000, from 98,000 a year earlier, according to Deutsche Bank Securities. Ameritrade’s daily average number of trades in that quarter was up 178%, to about 24,000, from a year earlier.

What’s more, trading activity appears to have picked up noticeably in the fourth quarter at several online firms as the stock market, and particularly Internet-related issues, surged.

Ameritrade said in late December that it was executing more than 32,000 trades a day in its December quarter, a 32% jump from the previous quarter. Rival Waterhouse Investors Services Inc., a unit of Toronto-Dominion Bank, said fourth-quarter trading volume leapt 50% in the same span.

It’s unclear exactly how many online traders are migrating from full-service brokers and how many are coming into the market for the first time. Online brokers say they see a steady stream of both.

In any case, the heightened trading activity by small investors is having a tangible effect on the market, some experts say. That’s demonstrated most clearly in the raucous gains in Internet shares in recent months.

Indeed, data suggest that last year’s surge in Internet stocks--in which major Internet indexes tripled in value and many individual stocks did far better--was propelled largely by small investors trading aggressively.

For example, in the two weeks ending Dec. 1, 77% of all trades in Internet bookseller Amazon.com were in increments of fewer than 1,000 shares, according to Plexus Group Inc., a West Los Angeles-based consulting firm.

Mutual funds and other institutional investors that move around millions of dollars worth of stock rarely trade in such relatively small share blocks. That means the bulk of those trades involved individuals.

By contrast, only 14.1% of trades in IBM shares in the same period were for fewer than 1,000 shares, suggesting comparatively little small-investor activity.

“I was astounded by this table when I put it together,” said Wayne Wagner, Plexus chief executive.

Increased trading has gone hand-in-hand with an increasingly volatile market. Individuals, of course, aren’t solely responsible for the pickup in intra-day stock movements. But their surge in activity clearly has added to the volatility. In turn, swelling volatility has attracted more trading.

The trend also has spawned an offshoot group of small investors known as day traders who trade stocks literally minute by minute with the aid of souped-up computers. Unlike other individuals who squeeze in trading around their regular jobs, day traders often bet large amounts and try to support themselves by trading full-time.

Not surprisingly, some experts worry that the new breed of traders will eventually get badly burned.

In their quest for immediate glory, traders often eschew fundamental research on the underlying companies--such as market share, sales growth and earnings--in favor of simply chasing hot stocks. That strategy could be ruinous in an extended market drop.

Also, active traders incur far heftier tax bills than buy-and-holders. Each time they sell a stock, they owe taxes on any gains. And because they rarely hold shares for a year or more, they don’t qualify for the usually lower capital-gains tax rate.

“I don’t think there’s much chance to be a successful trader over the long run,” said James Cloonan, chairman of the American Assn. of Individual Investors.

Then why are so many more people doing it? Several multiyear trends are behind the rise in trading, including plunging commission costs, the explosion of investment information available over the Internet (including many purported “hot tips” on stocks) and many mutual fund investors’ growing impatience with subpar fund performance.

Some brokerages now charge commissions of less than $10 a trade, making it possible for individuals to buy stocks even if they have a small amount of money or expect to make only minimal gains.

“You bring that [commission] cost down to $8 or $9 or $10 and all of a sudden $200 or $300 is enough to put into an individual stock without having trading costs overwhelm your returns,” said Jim Marks, an electronic-commerce analyst at Deutsche Bank in San Francisco.

Factors Behind the Trading Trend

But the prime factor fueling trading lately, analysts say, is merely that many investors perceive there are huge gains to be had.

Some individuals were initially drawn to Internet stocks because they are familiar with the technology. Just as renowned stock-picker Peter Lynch has long advised, they invested in what they knew.

Unlike many institutional investors, who were skeptical because most Internet companies had yet to turn profits, small investors were eager to get aboard what they saw as the first stage of a seminal new industry.

But as the stocks have hit stratospheric levels in recent months, the profits have come to look too easy, analysts say.

In some cases, stocks surge after simply being mentioned on CNBC, the financial news channel watched by many avid small traders. “I’ve seen CNBC knock a stock up 3 or 4 points,” said Jay Rosen, a day trader.

And “the better the market does, the more people trade,” said Nicole Vanderbilt, electronic-commerce analyst at research firm Jupiter Communications in New York.

For years, John Lauer, director of the active traders’ unit at Charles Schwab Corp., handled his family’s investments because of his job expertise. But last year, Lauer’s wife started trading on her own.

“I’ve seen it in my wife when she placed her first order over the Web,” Lauer said. “Almost immediately it was a profit situation. People are inspired.”

Although some critics say the growth of trading is dangerous for the market and for investors if it conditions people to focus only on the stock du jour, industry executives say that misses the point. Lower commissions and more timely information let investors do trades that previously wouldn’t have been possible. That is the market process at work.

“What we’re seeing is that the bull market, the volatility and the ease of in and out have made people’s threshold to do a trade lower, which has both good and bad results,” said Doug Doyle, director of product marketing at online broker E-Trade Group.

The extent of the small-trader-fueled run-ups in Net-related stocks such as Amazon.com, Yahoo and America Online has some experts convinced that individuals might play a big role in determining the direction of the overall market in 1999. If Internet stocks drop hard, they could drag down mainstream technology stocks, which have been one of the 1990s bull market’s primary underpinnings.

Others warn against extrapolating the growth of trading. When the market undergoes a prolonged downturn, many individuals will incur losses and will soon sour on trading, some experts say.

Even now, discount brokerages say that after the novelty wears off, the average investor’s trading activity declines over time.

“It’s just like any other hobby,” said Mike Anderson, Ameritrade’s president. “Some people stay with it while others fall off after a while.”

Still, Anderson and others expect more individuals to try trading in the years ahead, regardless of the market. Unlike in the past, the trading mentality is becoming ingrained as people become accustomed to taking a hands-on approach to investing, they say. And thanks to the Internet, small investors now have the tools to compete with professionals.

“It’s kind of like flying 45 years ago,” said E-Trade’s Doyle. “To go on an airplane trip was such a big deal that people put on suits and ties and thought about it for weeks. And now people hop on Southwest Airlines like it’s no big deal. And it is no big deal.”

Walter Hamilton can be reached by e-mail at walter.hamilton@latimes.com.

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The Rise of the Trader

Brokerages that cater to individual investors trading stocks via the Internet have mushroomed over the last year both in number of customer accounts and number of average daily trades. A look at data for two online brokerages, Ameritrade and E-Trade:

Number of accounts at quarter-end, in thousands:

1998

Q3

Ameritrade: 306

E-Trade: 384

Daily average number of trades, in thousands:

1998

Q3

E-Trade: 30.5

Ameritrade: 23.9

Source: Deutsche Bank Securities

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What They Play, What They Don’t

One way to determine which stocks small investors are trading most actively is to look at the size of the transactions. Trades of fewer than 1,000 shares are typically made by indivduals, because institutional investors naturally deal in much bigger numbers. Here’s the percentage of trades under 1,000 shares for six well-known stocks in the two weeks ended Dec. 1:

Stock: Amazon.com:

Trades under 1,000 shares: 77.0%

Stock: Dell Computer

Trades under 1,000 shares: 58.7

Stock: Microsoft

Trades under 1,000 shares: 45.7

Stock: Merck

Trades under 1,000 shares: 21.0

Stock: Coca-Cola

Trades under 1,000 shares: 15.6

Stock: IBM

Trades under 1,000 shares: 14.1

Source: Plexus Group