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Friday, September 08, 2006

Day Trading versus Investing

From Speechers Blog

The joke amongst day traders went something like this.

Q: When does a day trader become an investor?

A: When the trade goes against them and they just cannot let it go.

Or, in other words, they took the daytrade, it went against them and they are taking it home with them in the hopes it will be better tomorrow. Daytraders are often maligned on message boards, particularly in those situations where a stock has been headed up and then near the close, the selling begins. There are two ways to look at that. One, if the volume the daytraders are responsible for is enough to pull the stock lower significantly then it likely would not have gone higher anyway and secondly, any increase in the tick should be welcomed by investors. Daytraders by their very nature are extremely short term traders...anywhere from a few moments to a few hours but the rule of thumb is you never take the trade home. One of my students, who gave up their full time job last year to trade full time (a pretty gutsy move considering they have one child with another on the way but he is doing fine) contacted me on Tuesday as he often does to ask questions he still has on various market aspects. The stock he was talking about was TIE..he calculated the opening range LONG position or , at what point after the open will a move HIGHER be confirmed and what volume will it require to take it up to the target. The stock opened at 27.95, his LONG ENTRY was 28.16, LONG TARGET was 28.50, he sold half his position hear the target and TRAIL STOPPED the second half which triggered off the high of 29.20, the sold the remaining half of his daytrade just near the 29.00 level, and stock closed at 28.92 and today is currently trading at 26.38. So, he was able to take profit of .34 on the first half of his trade, then took close to .84 on the second half of the trade and was flat at the end of the day. It was a good daytrade but a bad investment.

The other criticism levelled at daytraders is they miss the bulk of the move. For instance, why would you want to see ABC company if the future is so bright? The daytraders have been selling it short for the most part each day since it fell from its highs while investors have been averaging down their losing positions. Now, some of those daytraders have also taken advantage of impulse moves off the low but overall, the trend has still been down, not up. Rather than continue to take losses as an investor, daytraders, if they are good, have been able to take advantage of the moves in both directions. When I teach my students I tell them normally to avoid going long on stocks where no short shares are available. The reason for that is quite simple. The market makers know that any new long positions can be gapped down leaving those investors with three choices. Hang on to your original position at a loss, average down and hope it moves higher or sell at the stop loss area and go flat. If the price moves down, or against a long position and there are short shares available, a trader could exit their losing long position and reverse positions and go short the stock. With no short shares available and you enter a long you have cut your options in half. Why limit your options? Not smart. Taser (TASR) was a great example and pre-split there were no short shares available when it was trading over $100.00USD. The stock moves all over the place but trading it is not for the faint of heart as the risk involved is huge. Yes, no risk no gain but quite frankly, who needs the stress. If you look at the chart for this year the stock is currently trading at $7.54, the high was $11.63 so those investors who bought nearer the highs are hoping for a major return to those highs. Not having a crystal ball I have no idea what would cause it to move higher or trade lower but the reality is, being stuck in a stock like that cannot be fun.

Daytraders are a unique lot of people with various backgrounds. Most fail. The reason most fail is like investors, they ignore the fact it takes a great deal of time to learn their trade and it is indeed a trade. Investors are a bit more laid back but over a longer time frame, they also absorb punishing losses. The only difference between a daytrader and an investor is daytraders lose most of their money over a shorter period of time while it takes longer for the same thing to happen to an investor. A few years ago I was doing a demonstration for Questrade of Toronto in a major mall in Calgary, demonstrating the then new CyberTrader product. There was a great deal of interest but what surprised me the most was the number of older people who had had a great deal of their money stripped away by companies like Nortel, and other "safe" investments which proved to be anything but. They were extremely bitter and very angry with the markets and their investment advisors as a whole. On the other hand a large number of younger people were intrigued with the possibility of making a lot of money very quickly daytrading. Some of those took jobs as prop traders which sounds like a great way of making very good money and it is but if your idea of fun is sitting in front of a computer scalping stocks and making a few hundred trades a day then go for it. I have spoken with a number of prop traders-a lot quit after two weeks, most are gone within a few months.

In a nutshell, daytraders on the big boards do not make the market. They identify the trend and hopefully trade with it rather than against it. They do not move the markets unless they take advantage of the dead zone to scalp the spread but I always say, the amateurs open the market and the pro's close it. You may be able to move the price around slightly but if the big money decides they are going higher or lower, there is not a great deal a daytrader can do to stop that and the close is often a very volatile time in which you can make or lose thousands of dollars in a flash. Daytraders can be beneficial in helping to move the price up during a day and even if it sells off near the close, if the trend is still positive, they will do the same thing the next day and so on and add temporary volume to a trend. TIE was a great example. My student identified the trend, he took advantage of it, made his money and got out and the stock fell. The overall trend was down, he caught the uptrend or impulse move and used a trailing stop to lock in his profits. He then smartly finds another play the next day or shorts TIE on the downtrend. To blame daytraders is not a big deal but a losing investor will normally place blame anywhere and everywhere except with themselves. How often do you read on a message board where a poster says..."I screwed up. I read the price was going to the moon and invested but it turned out to be a mistake and I am out of this pos stock!". The norm is more like "stupid shorters-they should all be put in jail"..."this has to be the most manipulated stock in the world"..."how come other companies are going up and we are going down...those banks are trying to get our shares cheaply so don't sell!"...and my favourite..."if those stupid daytraders did not sell the stock would be a lot higher by now.!"and so on. The other notion is that they firmly believe if they place their shares up for sale a great deal away from the inside bid or ask, say $10.00 or $15.00 higher, with the belief the shares cannot be used for short sales and if the stock continues to fall it is proof naked shorting is taking place. Like a lot of people today, it is everyone's fault but theirs why they are losing money. The market cares not a whit what you think you know.

The numbers may have changed and if they have it has been to the downside. Retail investors/traders accounted for less than 12% of the daily volume and that figure is likely less given the bloodbath most investors experienced in the years following 9/11. All 9/11 did was speed up the process as the markets already were in trouble. Still, the one common thread I see running through message boards is lack of knowledge. There was even one poster who claimed that buyers were hitting the ask, proof the stock was in accumulation. The interesting thing was the fact the stock was headed lower not higher and those who did buy the ask were fools because they could have bought it more cheaply. The marek of a good investor or trader is not in how much money they make, yes that is important of course but rather what they do when they face adversity. If the writing is on the wall it is far better not to ignore it. Unfortunately therein lies the rub, the writing is on the wall, but the vast majority have no idea how to read.

Remember, the amateurs open the market, the pro's close it.

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