MARKET WATCH

Day traders emerge as market forces

Investing for the long term is the mantra of the value investor. Hang in for five or 10 years, as Warren Buffett does, and you will retire in style. But defining "long term" is a highly subjective exercise. For a peculiar species of investor known as the day trader, long term is an hour and owning shares for a few minutes is routine.

Day traders are investors only in the broadest sense of the term. Using ultrafast electronic trading systems, they dart in and out of stocks and rarely hold a position overnight. None of the traditional measures of analysis and value is used and, in some cases, the people in front of the screen do not even know the business of the company they are buying or selling. All they care about is momentum. If a stock is moving up, they pile in, earn a few cents a share and bail out in droves the instant the tide turns. Do that enough times a day and you can make (or lose) a small fortune.

The advent of the day trader helps to explain the increasing volatility of the stock market in general and certain stocks in particular. If a stock that shows every sign of being kind to you suddenly plunges for no apparent reason, there is a good chance the day traders can be blamed. Their lightning-quick arrival and departure tends to exaggerate a stock's "normal" trajectory. This is why they are considered evil by traditional investors; to them, day traders are nothing more than quick-buck artists bent on whipping the market into a froth and turning everyone into nervous wrecks.

Day traders are quick to defend themselves. They argue they do everyone a favour by adding liquidity to the market and narrowing the spread, the difference between a stock's bid and ask price. In the past year, the typical spread on a Nasdaq stock has narrowed by about 30 per cent, meaning both buyers and sellers are getting better deals.

Day traders have been around for years but two factors -- technology and the raging bull market -- have turned them into market forces. Experts think this new army of traders can account for as much as 20 per cent of the trading volume on Nasdaq, their favourite hunting ground.

Advances in trading technology have given them the ability to trade more quickly than the top houses on Wall Street. A day trader at a small firm in New York says the relatively cheap software he uses allows him to flip a stock faster than mighty Fidelity Investments, his former employer, which spends hundreds of millions a year on technology.

Day trading is not limited to the professional day-trading shops, such as New York's Schonfeld Securities. Anyone with the stomach to put their own money on the line can play the game. Small U.S. brokerages, such as Broadway Trading, offer an easy route in. Broadway supplies wannabe traders with a trading room and the hardware and software required to use the electronic communications networks that post prices on Nasdaq's market-maker system. Broadway charges customers 2 cents (U.S.) a share in commissions on trades and, for another $1,200, will train neophytes on the art of day trading.

The technology allows you to trade from home. A number of Internet services, such as the Pristine Day Trader, provide a "virtual" trading room where clients can obtain a steady flow of stock market data, commentary and trading tips. "Breakouts and stocks that are on the verge of exploding to the upside are issued in a matter of seconds," its promotional literature says.

The bull market, particularly among technology stocks, has been a day trader's dream in recent months. Traders who can take phone calls -- conversations, not surprisingly, are usually limited to five-second bursts -- claim they have made killings on Yahoo, Amazon.com, Lycos and other gravity-defying Internet names. Yahoo gained $26.37 one day last week.

Stocks, though, do not have to soar into the stratosphere to make money for day traders. They are happy to sell shares for 1/8 or even 1/16 of a point (known as a "teenie") higher than their purchase price. If you buy enough shares, say 1,000 at a time, and do it often enough in a day, you can go home with a tidy profit. The bravest players will buy on margin, giving them greater exposure to a particular stock, or go short, allowing them to make money when shares go into reverse.

A day trader in New Jersey says the one golden rule is to go for big, liquid stocks. "The key is to be able to get out in a hurry," he says. "When a stock goes into reverse, you don't want to face a vacuum of buyers and sellers. That's when you can get murdered." Stocks with volatile trading patterns are also favourites because they have more potential for short-term gains.

Whether you like it or not, day traders are here to stay and they are coming to Canada. Although no professional day-trading firm such as Schonfeld exists, some Bay Street firms are devoting an employee or two to the business and home-day traders, equipped with their fancy Internet software, are popping up everywhere.

They should be encouraged. Their advent has helped to break the near monopoly of the big, expensive market makers, adding a healthy dollop of democracy to the stock markets. "We help to level the playing field," one trader says.

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