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Wall Streak

[whitespace] day traders
Christopher Gardner

A new generation digitally taps into the stock market, buying and selling at the slightest fluctuation, making or losing fortunes in minutes

By Michael Learmonth

SAN JOSE'S DECIDEDLY un-glitzy Town and Country Village wears the vagaries of the local economy on its sleeve. Across the mostly empty parking lot from a Mailboxes Etc. and a tobacco shop, Patio World is advertising a firesale on overstock outdoor furniture. The Young Set, a children's furniture store, is going out of business, claiming, "We're selling the fixtures!"

A few doors down, inside a tinted glass storefront, the sleepy, analog atmosphere of the '60s-era shopping mall succumbs to air-conditioned tension as a group of three dozen people test their wits against the whipsaw global economy and risk financial undoing.

Jim Salehi sits intently in front of two computer screens covered with flashing colors, tables and graphs, tracking the stock price of 3Com, the Santa Clara-based maker of computer network equipment.

"I almost never hold positions overnight," he says, as he unloads 1,000 shares. In fact, Salehi, a dark-haired, 33-year-old former network engineer, rarely holds any position in the stock market longer than 15 minutes. He's one of three dozen market renegades on the electronic trading floor of Pacific Day Trading Inc., a brokerage firm that allows customers to tap directly into the Nasdaq via a proprietary network and risk their personal capital against the likes of giant brokerages like Merrill Lynch, Goldman-Sachs and Charles Schwab. Some are losing quite a lot of money. Some are making bank.

"I'm competing against the market-makers: people in New York, the specialists, the brokerage houses," Salehi says. "I'm trying to take their money and they are trying to take mine."

Today was a good day for Salehi--not his best, mind you--but when he turns off his computer for the night he'll head home $4,000 richer.

Salehi, who started day-trading stocks six months ago, has no intention of slowing down.

"I want to see how far I can take this," he muses. "Will the ceiling be 1 million, or will it be 5 million?"

Salehi is a member of a growing class of do-it-yourself investors known as day traders. Rather than following the Warren Buffett investment style of doing exhaustive market research and sitting on shares of solid companies for years, Salehi rarely sits on anything longer than a few minutes, except his swivel chair. And four days out of five he sells all his holdings before the markets close at day's end and he converts all of it to cash.

The subject of some derision from pin-striped brokers and Chicken Little market pessimists, day traders are an oft-misunderstood bunch. First off, there are very few true day traders; that is, traders who make many trades a day to profit from short-term fluctuations in the price of a stock. Most people signed up with an online brokerage--like Schwab, Datek and E-Trade--are not day traders, because they don't swap stocks frequently enough. Of the 8 million people buying and selling stocks online, only an estimated 3 percent make more than five trades a month, and less than 5 percent trade with any kind of frequency.

Nevertheless, there are perhaps tens of thousands of people trading stocks electronically several times a day. Added to traders like Salehi, who comprise an estimated 3,500 traders on electronic trading floors like Pacific's, that's the number of people trying to make money as day traders in America. Demand for DIY investing services is growing. Experts predict there will be 25 million online traders by the year 2003. But it's almost impossible to tell if that will lead to more day traders.

"There is a finite universe of people who are good at day trading," says Rick Roberts, a former SEC commissioner and the Washington, D.C.-based legal counsel for the Electronic Trading Association. "The customers at online firms are going to continue to explode. I don't know what percentage of that crowd is going to be an active trader. It may shrink as the failures shake out."

At Pacific Day Trading, failure can come brutally fast. For a full-octane, direct-to-Nasdaq electronic account, Pacific requires customers to set up a minimum brokerage account of $25,000. Day traders typically buy into the market in no less than 500-share chunks to cover the transaction fees, which run $22.95 each way, or $45.90 a deal. A more typical buy is 1,000 shares. A healthy quarter-point gain on 1,000 shares nets $250. Minus $45.90 in transaction fees, the trader takes home a $204.10 profit. But if that was a $50 stock, the trader had to risk $50,000 to make $204.10. Further compounding the risk, Pacific allows traders to borrow on 50 percent margin, so a trader with $25,000 in cash or stock has $50,000 in buying power.

The falls can be fast and furious.

day traders Finger Pointing: The SEC has investigated a rash of complaints involved with electronic trading of stocks and is concerned that day trading is taking the form of gambling.

Christopher Gardner

ON THE LIPS of Pacific trade-floor regulars is the story of a recent catastrophe, the story of a woman named "Josie" who lost her entire $25,000 nest egg in less than two days on the male-dominated trading floor.

Josie got thrown from the back of the bull before she'd even had a chance to ride. But a spirit of camaraderie pervades the floor. People talk, give heads-up on hot stocks, share secrets and give moral support. Josie even allowed Salehi to look at the trades that sent her packing.

First, Salehi says, she bought a weak stock--not usually fatal; it was several subsequent mistakes that sealed her fate. She bought too much of the stock on margin--on money borrowed from the brokerage. Then, instead of selling and taking a loss when things started to look bad, she held on, hoping for a turnaround. Then, sin of all day-trading sins, she held the stock overnight--it opened the next day nine points lower than it had closed.

Mistakes are easy to analyze when it's not your money. At the end of the day, Salehi looks at all his market moves and asks himself the same question: "Was it a good trade? Would I do it again?"

Salehi believes not everyone is able to make the kind of cold, analytical decisions the market demands when they've got $50,000 of their hard-earned cash on the line.

"There are professional traders out there who live to take other people's money," Salehi explains. "I don't think most people are going to be able to compete."

But the vast majority of the day-trading casualties occur in the privacy of the electronic trader's own home. Tim McAdams, president of Pacific Day Trading, says that for some reason people don't apply the same caution to buying huge amounts of stock at online brokerages that they would in, say, giving their credit card numbers over the Internet.

"The same guy who wouldn't buy tennis shoes over the Internet is going to e-trade," McAdams says. "The same guy who won't go online to shop will use their ISP to buy $161,000 of Yahoo stock."

Internet trading of stocks has revolutionized the financial markets. Once behind a well-guarded gate of stock brokers and financial professionals, the market is now open to anyone with a computer and a modem. Initially, this had Wall Street apoplectic. Now, as most of the big brokerages have gotten into the online investment game, the SEC is faced with protecting people from a new kind of investment fraud and, perhaps more importantly, protecting them from themselves.

"Strategies such as day trading can be highly risky, and retail investors engaging in such activities should do so with funds they can afford to lose," warned SEC chairman Arthur Levitt in January. Responding to a 330 percent increase in the number of complaints, the SEC has embarked on a major securities-fraud dragnet online that netted 13 suspects.

Jim McConnell, a Los Gatos investment planner who recently testified in front of the SEC, says the commission is concerned that people will lose their retirements and homes online.

"When people get into this, hopefully they are not trading their retirement accounts," McConnell says. "It's like a business. The SEC is concerned it [the stock market] is treated like a casino."

FUTZING WITH investments threatens to supplant email as Silicon Valley's No. 1 cubicle time-suck. It stands to reason, given the number of high-tech workers who are partly compensated in stock. It's a short step from casually checking your net worth five times a day to starting to move things around a bit, to becoming a day-trading stock junkie.

Salehi confesses this is how he got his start, while he was working as a network engineer at Hewlett-Packard. He started showing up at work earlier and earlier to get in on market action before the start of the workday. Then he started to make trades between meetings and in any spare moment before the markets' close on the West Coast at 1pm.

Salehi swapped stock tips via email during the day with friends at Sun Microsystems and Philips, but soon he left them behind to focus on stocks full time.

"There are a lot of people in Silicon Valley making trades in their cubes," he says. "I just wanted to spend more time on it."

As a full-time job, the trader's day begins at 6:30am PST. Pacific day traders start trickling in a half-hour earlier, steaming aluminum cups in hand. In the trading room, the computers boot up and CNBC comes to life on overhead monitors. The trading floor is most crowded in the morning. Quite a few traders come for a few hours in the morning to get a little market action before work.

"I go in streaks," says Dennis Dolen, 52, who holds down a full-time day job as general manager of Sunnyvale Volkswagen. "I wait until the market makes a move and I jump in. If the market's slow, I stay away from it."

While online traders risk whatever congestion prevails on the Internet, traders on the Pacific floor are tapped directly into the market. By law, orders must be filled within 15 seconds.

"You wanna trade with the big boys?" McAdams says. "You're trading with the big boys."

It is, in effect, like being on the floor of the New York Stock Exchange without all the ticker tapes and yelling--a good thing at this hour.

McAdams, 39, stopped day trading himself two years ago when he started Pacific. "I better fit the business mode than the trading mode," he says. McAdams is a gregarious salesman, a self-made high school graduate from Columbia, Tenn., who came to Silicon Valley 17 years ago to seek his fortune. A couple more years of this, he says, and he'll have "enough money shoved in the bank to work when I want to."

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PART OF MCADAM'S JOB is to educate new clients about the risks. McAdams calls all newbie traders "dumb money." To make the money on the floor a little smarter, Pacific offers--indeed, highly recommends--a 16-hour class, Day Trading Boot Camp.

In boot camp, prospective stock market mavens aren't taught to value a company, read an annual report or interpret an SEC filing. They are taught how to judge what a given stock is probably going to do in the next five minutes, how to catch waves in the stock price and--more importantly--how not to get caught without a chair when the music stops.

Classes for beginners at Pacific begin after the market has closed for the day. On the third day of boot camp, 13 men and two women sit in folding chairs, taking notes and listening attentively as instructor Kim Wong draws the jagged line of an ascending stock on the dry-erase board.

"Day trading is not dependent on inside information or big-shot analysis," he explains. "Discipline is the key. Getting out of losing positions is the key to protecting yourself."

For a blue-suited stockbroker, Wong seems to dwell quite a bit on psychology in his lecture. The two most dangerous emotions he keeps talking about are "greed" and "fear."

"I am an advocate of trading fast," he says. "With short trades you're not letting your emotions, your bad psychology, to come in and haunt you."

He marks on the line the ideal points to buy and sell a stock. Certain line patters are predictable, he says. It pays to become familiar with a stock, its normal fluctuations, to recognize when it's about to break out of the norm, either rising or falling in price.

"Day traders probably don't have an M.B.A. degree," he concludes. "They are disciplined and nimble because day trading is very simple."

Graduates of the class are offered 65 hours of free "paper trading," during which they are using the software and interacting with the market, but none of their trades really count.

Dave Morgerson, 38, made $1,150 his first day paper trading. A former Navy helicopter pilot, he started dabbling in mutual funds in 1988. When the Internet brokerages came online in the mid '90s, Morgerson was infected with the stock market bug.

"It just snowballed," he says.

He left the military, got a graduate degree in finance and came to the Bay Area to look for work. Day trading just looked like a lot more fun than a real job.

"This morning I watched Microsoft," he says. "It was flat. So I went to Dell and Amazon. While I was dallying there, I missed a big dip at Microsoft, a perfect time to sell short."

"It was an opportunity lost," he laments.

His neighbor, Alan Murphy, a ruddy Santa Cruz resident who says he stopped surfing the "big stuff" 10 years ago, is trying to get used to the feeling of catching a stock market swell.

"You've just gotta catch them at the right moment," he says. "It's stressful. My first paper trade I had to get up and walk around the mall just to come down."

When Salehi left HP to try day trading full time, he had $60,000 saved. After completing boot camp in September, he opened a brokerage account with $25,000 from savings and started trading.

"My first goal was to survive, learn and pay my bills," he says.

While there are plenty of people who come into Pacific to execute trades before heading to work, Salehi wanted to trade full time. He figured he could handle the risk. He's single, lives in an apartment in Sunnyvale and has no dependents.

"I'm not distracted by other commitments," he says. "My expenses are low and my tolerance for risk is high."

The first three months were, to put it mildly, a disaster.

Salehi was getting, as Tim McAdams likes to say, "slapped by Morgan Stanley" on a daily basis. He watched his $25,000 account dwindle to $7,000.

"I thought I was going out of business," he says.

Beaten but not yet broken, Salehi kept showing up at the trading floor at 6am, trading every day the market was open from Thanksgiving until Christmas. Soon, things started to turn around.

"The 70 percent down reflected what it took to learn the system," Salehi says. "Now I've way more than recouped it."

In fact, Salehi says he's made more in the last few months than he did in an entire year at HP.

THE FIRST FEW minutes after the market opens can be dicey, but as he's gotten more savvy, Salehi's been able to make a quick buck jumping in and out as stocks find their feet for the day.

On this day, Salehi is watching several disparate stocks, all related to either high tech or e-commerce. When Bluefly, a retailer of off-price name-brand clothing, started selling products online, Salehi became interested. "Instant Internet company," he says. "I mostly play Internet stocks because they move around a lot."

Today Bluefly's stock price moved 30 percent, from 12 to 16 points, after an announcement that the CEO of the company was to appear on CNBC the following day.

"People are buying the stock because they anticipate he will say something good," Salehi says.

This is just the kind of short-term joyride that can make Salehi's morning. The day trader's penchant for Internet stocks is largely a function of their volatility. No day trader makes money on a flat stock. They cruise the stock market for issues that are shooting through the roof or crashing through the floor.

Salehi makes his first $500 shortly after 11am. He noticed Mountain View-based software company Intuit's stock was climbing, so he bought 500 shares at 11:11am. Four minutes later, after the stock had gained a full point, he clicked "sell."

"I loaded it on some sucker," he says, marveling at the absurdity of it all. "I don't know what happened to the stock. I don't care."

A one-point gain on 500 stocks, of course, is a $500 net gain. Out of that, he has to pay $22.95 for both trades, leaving $454.10 in his pocket.

Making money on the upward trend in stocks is intuitive. But the day trader doesn't really care if a stock is going up or down. Any fluctuation can be profitable.

Take the downward-trending stock. Salehi saw Visx, a Santa Clara company making lasers for eye surgery, take a turn south, so he short-sold 500 shares at $79. Short-selling stock, a favorite day-trading gambit, means locating a falling stock and agreeing to sell a certain amount to a buyer at the current price, but then waiting until the stock price has actually fallen below it to fill the order, in some cases netting several dollars per share. In the case of Visx, Salehi waited seven minutes, then bought stocks to fill the order at $78.25 for a profit of three-quarters of a point, or $375.

Veteran traders share tips, tell jokes and sometimes cluster around one another's computers. They've seen their share of calamities, and they're determined not to become market road kill. A shaggy-haired gentleman wearing a 49ers sweatshirt is exhorting Salehi to check out 3Com stock.

3Com seems to be a Pacific favorite, at least on this day. The computer shows Pacific traders alone have placed orders for 50,000 shares of its stock at 24 1/4.

After the market closes at 1pm, the trading room seems to let out a collective sigh, the graphs and tables on Salehi's two monitors start slowing down from a tango to a waltz to swaying gently in place. The man at the next work station speculates with a grin that his darling 3Com may soon hit 30.

Salehi's other friends slowly get up to exchange a few brief post-mortems before they leave for the day. One pretty blonde woman, sitting opposite Salehi, stands up and walks over to lament that she had just taken a seven-point loss on 800 shares, a $5,600 mistake.

"I fell in love with the stock," she mourns. Salehi reassures her, saying he's had his own share of $8,000 learning experiences. The woman goes back to her monitor to pack up to leave. She's dressed casually, more for the beach than the trading room. But perhaps the beach is where she's headed next. Even bad days of trading end at 1pm, leaving plenty of time for other, less stressful pursuits.

After six months, Salehi's pretty sure he's found his calling, or at least what stimulates him now.

"I'm not in this for the money," he says. "I'm in it because I like it."

And who wouldn't like to make $4,000 in one day of pointing and clicking stocks, staying sharp and keeping one beat ahead of the market?

Says Salehi, "This is the best game I've ever played."

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From the March 18-24, 1999 issue of Metro.

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