The New Stock Traders
A deputy sheriff in Oregon. A software consultant in Atlanta. A retiree in Florida. An entrepreneur in California. Far from the concrete canyons and electronic ticker tape of Wall Street, these are America's new stock traders. Their trading posts: the computer in the extra bedroom or their desks at work. With an ever-expanding array of real-time news services and increasingly powerful analytical software available on low-cost Web sites, these populist traders can mimic the big guns and trade at the click of a mouse.
Certainly, the new individual investors emerging from the 16-year bull market are not forsaking stocks as long-term investments. But they are waking up to the shorter-term opportunities in the market. For the most part, they don't have the time or the desire to be rapid-fire day traders glued to their computer screens all day long. But the information and trading tools at their fingertips are encouraging them to explore an array of short-term investment strategies that, they hope, will complement their long-term holdings. If parking money in stock-index mutual funds produces double-digit returns, they figure, why not take advantage of all the new information and analytics on the Net to do even better?
FALSE CONFIDENCE? Never before have individual investors been so empowered, and never before has managing their own money been so easy and so appealing for such a broad swath of people. The phenomenon of more active trading stretches from compulsive traders making dozens of trades daily to a far greater community of people trading a few times a month. Forrester Research Inc. senior analyst Cliff Condon says the number of online investing accounts has swelled to more than 3 million today, up from 1.5 million in mid-1997. That's just part of the story. Add in people without online accounts who are trading via the telephone, and estimates for the total number of individuals trading two or more times a month go as high as 5 million. According to Condon, there could be 14 million online accounts by 2002.
The impact of these new traders on the market is not yet clear. Are they a source of added volatility? Or, by buying on dips, do they provide liquidity that dampens volatility and compresses market cycles? Nor is it clear whether investors will profit in the long run if they focus too much on the short run. These investors, many of whom zero in on notoriously volatile technology stocks, may be adding greater risk to their portfolio at precisely the time when the long bull market has made them less attuned to the downside risks in the market. If investors develop a false sense of confidence in their investment skills and keep ramping up their risk level, any downtrend in the market may hurt them more than in the past.
What is clear is that these individuals are becoming a potent force in the market and may provide buying support that keeps an aging bull looking spry. True, some of them mistake the parade of ticker symbols on CNBC for the glittering lights of the Vegas Strip, but most are learning sometimes painful lessons that will make them more educated and demanding consumers of financial services. As a service industry springs up in pursuit of the immense profit opportunity represented by these traders, competition for their business will drive costs down and services up--to a level that puts institutions and individuals on a more level playing field.
These investors are not just trading individual stocks but also mutual funds, options contracts--even their 401(k) money. For many, the Internet, with its myriad low-cost online brokerage sites, affords freedom and control over their money that they find invigorating. Since many people trade in tax-deferred retirement accounts, they don't worry about paying taxes on short-term gains. Those trading in taxable accounts believe they can earn returns big enough to make it worth it, even after paying the tax.
"Online trading has been the answer to my prayers," says Milt Taylor, a 71-year-old retiree in Naples, Fla.. "No one gives you advice or tells you not to buy or sell that many shares of stock, and I love that. I like to make my own mistakes and have no one to blame but me." Says Jennifer Ciekanski, 27, a former programmer now bartending at a Cleveland club: "You get into it a lot more when you're doing it yourself, rather than giving a broker your money."
POPULAR OPTIONS. A telling sign of the increasing sophistication of investors is the popularity of options trading. Attendance at educational seminars hosted by the Chicago Board Options Exchange's Options Institute has tripled since 1992, as the number of seminars has soared from 32 to 128. "Investors are unequivocally asking for more information and information of a higher level than in the past," says John R. Power, vice-president of the CBOE's institute. Sue E. Benac, 45, who has a software consulting firm in Atlanta, B&B Consulting Services, started trading options after taking a course last October (below). "Since the class, I've been doing more trading, and the results have been profitable," she says.
As more investors choose online investing over the more traditional discount brokerage route, their trading is increasing. As a rule of thumb, Julio Gomez of Boston-based Gomez Advisors Inc., which specializes in Internet brokerage, says activity doubles when a discount brokerage customer moves from telephone to online trading. Piper Jaffray Inc. analyst Bill Burnham estimates that by yearend, online trading could account for 30% of retail volume, up from 17% in 1997. Within three to five years, he says, 50% of retail volume will come from online trading.
The number of firms offering online trading has mushroomed. Gomez now tracks more than 60 such firms, up from 27 a year ago. The industry leaders are Charles Schwab & Co., the largest discount firm, and E*Trade Securities Inc. A fierce battle for market share is being waged, however, with firms such as Waterhouse Securities, Datek Online, and Web Street Securities coming on strong.
Fueling the surge in online trading are plummeting transaction costs. "Cost was artificially inhibiting trading," says Gomez. "You needed the stock to move several percentage points just to recoup transaction costs." In 1997, the average commission charged by the top 10 online brokers fell by more than 50%, from $34.65 at the start of the year to $15.95 at yearend. And cheap trading on the Web is driving prices down at discount brokerage and full-service firms alike.
The market break last October showed firms just how active investors could be. Many 401(k) sponsors saw more money move among funds than expected, especially in funds offering company stock. In general, investors are keeping a closer eye on their 401(k)s, with the average number of annual phone calls per participant for plans administered by American Express Retirement Services rising from 1.5 calls per participant in 1994 to 6 calls per person in 1997.
For better or worse, some individuals are finding that the cheapest place to make short-term moves is in their retirement account. Many 401(k) plans have low fees or no fees for transferring money between funds. One investor makes bets that foreign stock markets will generally follow the U.S. market. If the U.S. stock market looks like it will close lower, this investor switches money out of his 401(k)'s foreign funds just before the market's close. The next day, if the Dow Jones Industrial Average ends on an up note, he moves money back into foreign funds shortly before the closing bell. He says his returns have outpaced the averages. Says another investor trading a six-figure position in the Standard & Poor's 500-stock index fund in his 401(k): "It's the cheapest way to play the S&P." A pension fund consultant tells of a client who has a veritable investment club market-timing their 401(k)s. Five men check their accounts daily, call one another, and then speed-dial changes to the plan's 800 number.
MARKET TIMERS. The next big trend among 401(k) plan providers is to make accounts accessible through the Internet. By the end of 1998, clients of American Express Retirement Services will be able to go on the Net and transfer balances, change contribution rates, and change the percentages allocated between funds. If individuals react the way they did when introduced to online trading, they may start trading their 401(k)s more than ever. That's not necessarily bad: Such sites often offer a lot of educational material as well as planning tools to help investors allocate their money.
Active traders of mutual funds have long existed, but the bull market may be egging them on. Bruce A. Ogilvie, chief financial officer at Santa Ana (Calif.)-based Contour Design Inc., which makes ergonomically designed computer mice, used to own more than 20 mutual funds at once but says that hurt performance. He has winnowed his holdings to about 10 funds. On Oct. 28, 1997, Ogilvie, who trades often, bought heavily into Hong Kong mutual funds when he saw the U.S. market staging a big rebound after its 554-point fall the day prior. The next day, he watched Hong Kong's Hang Seng index rise 12% and put in a sell order. He says his portfolio is up more than 20%.
Fund managers do not like "market timers" because the rapid inflow and outflow of money disrupts their strategies and can mean higher expenses and capital-gains taxes for other fund shareholders. "I know fund managers complain about too much trading, but they do the same thing," says Ogilvie. "They constantly sell and get out when they want to."
FEVERISH MARKETING. After the market break in October, the switching became such a concern that the mutual-fund industry went on the offensive. A number of fund families and fund supermarkets have added loads or are reviewing how to change their fee structures to discourage market timers. But as fund families add barriers and fees to discourage them, other firms are creating funds expressly for such traders. Bethesda (Md.)-based ProFunds launched a family of funds last November that has no loads, fees, or restrictions on moving between funds. "Many market timers try to stay beneath the radar of fund companies," says Michael L. Sapir, the firm's chairman. "However, especially recently, fund companies have sought to both protect and eliminate investors who are trying to time the market with mutual funds."
Sapir says that his funds keep transaction costs down by anticipating large swings of cash between funds and investing in exchange-traded futures and options contracts to replicate the funds' benchmarks. Since the futures and options contracts they buy are settled the next day, "we can have liquidity on any redemption the next day," he says. So far, the funds have attracted $50 million.
The biggest number of new products aimed at short-term traders, however, are making their debuts on the Web. Many firms are feverishly altering product lines and business plans to appeal to these new traders. The incentive for information providers to offer accurate, timely, value-added information over the Web and to help people interpret it correctly, is huge. Firms such as PC Quote Inc. and Telescan Inc., which have long geared their software to sophisticated investors, are revamping their offerings. "The Internet brought us more of a `common man' type of market," says Jerry Smith, a Telescan vice-president. "To remain customers, people have to use our technology and make money with it. So we've spent almost all of our time translating capabilities to the beginner level and are adding a lot of educational material." PC Quote CEO Jim R. Porter says firms such as his realized that "if we begin to empower the individual with the tools to manage their own assets, their motivation will afford them the possibility to do this better than some broker is going to do for them, perhaps." At the least, he adds, "I think they'd like to try."
Another firm targeting a wider universe of traders is Iselin (N.J.)-based Datek Online Holdings Corp. The firm used to cater just to users of the small order execution trading system, or SOES, which allowed traders to pounce on fleeting pricing irregularities between bid and ask prices for NASDAQ stocks. "Datek is trying to court a broader audience, but their core is very aggressive retail traders doing a lot of volume," says Burnham.
Are the efforts of Datek and others to engage and educate the average investor in short-term trading setting investors up for a fall? Or will such efforts help develop better investors? Susanne D. Lyons, who heads Schwab's active trader and affluent customer business, believes the Internet is making investors less tip-prone. "People used to buy on tips they heard at cocktail parties," she says. And sure, there are a lot of tipsters on the Net. Now, people are "more likely to go look at a price chart and make a better informed decision than a tip-oriented buy," says Lyons. "People trade more when they start using the Net, but they're not churning and burning. The wealth of information and news shows them opportunities they didn't see before." Adds Stephen Killeen, a senior vice-president at Fidelity Brokerage Group: "I'd be more worried if the information wasn't there and people were trading willy-nilly."
Of course, amateur and professional investors alike will make mistakes. The difference now is that more may learn from their mistakes. As one online trader, a 50-year-old Manhattanite who trades 10 or so times a day and did not want her name used, puts it: "If a broker recommends something you buy and then you lose money, a lot of things go through your head about why that happened. When you're doing the picking, you know why it happened." The investor says she averages a gain of $1,200 a day on a $50,000 portfolio.
TRIGGER-HAPPY. The new investors learn by doing. Martin Gruen, 58, mastered a big lesson years ago: He did not have a career as a day trader. Gruen, of Morristown, N.J., worked for a major investment bank in private client services before retiring a few years ago. About 10 years ago, he tried day trading, chasing after eighths of a point, "and learned an expensive lesson. I found out I'm not very good at it." Gruen has a quarter to a third of his portfolio earmarked for short-term trading and makes about one big trade a day. He now picks stocks based on factors he thinks will affect prices within two to seven days--such as the market overreacting to fears of an acquisition being dilutive to a company's earnings.
This phenomenon of more active trading is not without a potentially significant downside. "In this next wave, we will have people intoxicated by the convenience, the utility, and the bull market, and they may end up making investment decisions they regret," says Burnham. Robert J. Farrell, senior investment adviser at Merrill Lynch & Co., wonders if the bull market is making investors overconfident. "We're giving people tools to convert to a short-term point of view--now they can even trade the Dow Jones Industrial Average on the CBOE--and most of the pros aren't beating the averages," he says.
One of the most common mistakes investors say they make is being too trigger-happy. When bartender Ciekanski started trading, she'd buy and sell for a quick gain. "Lots of times, I'd sell it real quick and then two to three months later I'd see it way up," she says. "I'm learning to hold on to stocks longer." Joseph Kast, a 31-year-old deputy sheriff in Salem, Ore., can sympathize. After buying the stock of E*Trade in the high teens and selling it in the mid-20s, he watched the stock rise to 47. "I made money, so I can't complain, but still, the company looked good at the time I sold," he says.
Other investors, however, say they stumbled by hanging on too long. Gruen's results were ahead of his expectations for the first quarter, but he's off to a rocky start in the second quarter. "The damage was self-inflicted," he says. "It reminded me of something I already knew--that when a trade works out, I should take a profit and walk away instead of hanging around for more."
It can be less painful to make mistakes with commissions so low. Says Taylor, the Florida retiree: "With my Schwab account, I can take a position in a stock for, say, $30. At other places, the commission could be $300 to $400. I can sell a stock, then buy it back, and I don't feel like it's costing me an arm and a leg."
Increased short-term trading leads to increased volatility in the market, says Robert J. Froehlich, chief investment strategist for Scudder Kemper Investments Inc. "A lot of people are not focusing on the next month or quarter, but on where the market will be tomorrow," Froehlich says. "It adds volatility to the market and creates the appearance that they can make money in the short run by outsmarting the market--and no one can do that."
"GAMBLING." That critique has been made by countless people. But a lot of people who advocate investing for the long run are unable to beat the market as well--among them the fund managers at Zurich Kemper Funds before the funds were purchased by Scudder, Stevens & Clark Inc. last year. At the time of the deal, the funds had been underperformers for years, with only 10 of their 116 funds meriting a four- or five-star rating from Morningstar Inc., the mutual-fund data service. In general, sticking to the wrong discipline can bring investors serious losses. Holding on to gold funds, for example, has been disastrous for thousands of people.
It's the fear that mainstream America will take to playing the stock market with the same gusto that they play slot machines in Las Vegas that worries many market watchers. With the spread between bid and ask prices narrowing and with transaction costs so low, "a lot of people are approaching the stock market as a gambling game," says Jeremy J. Siegel, professor of finance at the University of Pennsylvania's Wharton School and the author of Stocks for the Long Run. That doesn't mean that their bets will necessarily translate into greater market volatility, however. "I don't think their aggregate money is such that they can compete with institutions selling 10, 20, 30 times as much on each transaction," says Siegel.
Many investors seem to recognize the risks they're taking. Tushar Shah, a 23-year-old consultant in Manhattan, has spent the past year trading a chunk of money saved for him by his father. Shah, whose portfolio is tracking the broad market, notes that "the Web is a great democratizing force, but it's hard to distinguish between good and bad sources of information, and with stocks, that's crucial."
Nevertheless, Shah says, "it's better than before, when people didn't have any access to information."
In the midst of a raging bull market, investors are stepping up to the challenge of managing more of their money. If the bull stumbles or turns into the unthinkable--a bear market--all of this empowerment may not be viewed as the great blessing that it is today. For the time being, however, the enthusiasm of the new traders is, like the stock market, reaching new highs.