The Motley Fool: The Fribble, Day-Trading, by George Runkle

Thursday, April 16, 1998

Day-Trading
Fun and Profit or Just A Random Walk Through an Efficient Market?
By George Runkle ([email protected])

Recently in a chat I hosted, a woman in the room wanted to discuss day trading. She was curious how she could learn about doing it. I really can't blame her. Now, seriously, wouldn't it be cool to be a day-trader? Instead of going to work every day, you could stay home and call your broker every ten minutes and yell, "SELL LU!" You could watch CNBC all day and jump at each little bit of news. Want to leave the house, no problem! Just take your cell phone with you, and one of those doodads that gets you instant quotes. It would be a lot of fun. You'd look cool on the golf course, too, with your cell phone and thing-a-majig for stock quotes.

Now, one of the problems I've had with my deep-discount broker is that they aren't really good at answering the phone. My other discount broker, Fidelity, is, but heck, you want those cheap commissions, don't you? If you go in and out of positions several times a day, you want those trading costs to be low. So, you may want to shop around a bit to find a deep-discounter that is always available. Web access would help more, or better yet, get a Level II trading station. I don't know how to do that; I'm not a day-trader, but you probably have to get some extra phone lines and stuff in the house. I guess the trading station is kind of steep, too, but you really need it. Of course tracking gains and losses for taxes would be a bit difficult. I imagine your Schedule D would look like a phone book. That's a small price to pay, of course.

To make money in short-term trading -- I mean day-trading, not namby-pamby in and out of positions every month or so -- you have to be fast. If you are going to buy or sell stock on news from CNBC, the institutions with their traders will beat you otherwise. Now almost all academics say that stock prices move randomly over the short term. In other words, they go up and down during the day based on news that can't be predicted, or rumors that spread through the floor traders and institutions. They claim that day-traders who succeed are taking a "Random Walk."

What's a Random Walk? Well, have 100 people flip a coin. 50 will call it right. Have those 50 flip the coin, of them 25 will call it right. When those 25 flip, 12 will call it right. Keep doing it, and you'll be down to one person who consistently called each coin flip correctly. What does that tell you? It tells you that he's going to write a book called Success in Coin Tossing, he'll be on CNBC, and he'll make a fortune giving seminars on his methods. It tells academics that he took a "Random Walk" statistically. What do they know? To be fair, these same academics claim security markets are "efficient" and you would be just as well picking stocks with a dartboard than any kind of analysis. This is quite amazing, because people never seem to do anything efficiently, but now in the Twentieth Century we have apparently achieved that with our securities markets.

Now, how do you find a sure-fire method for day-trading? No problemo, my mail box is always full of ways guaranteed to make you gajillions on stock trading. How do you know which one of them works? I guess you have to take their word for it. Would a person lie to sell newsletters, books, etc? I've spoken to several day-traders on-line who apparently are quite successful. Are they on a Random Walk? I don't know if it's that, or they found a good method. One did mention that if you have found a good method for trading, you're too busy using it and making money to write a book about it. If so, that means it is even harder to find a successful way to trade if you never have done it.

What happens if you are not a good trader? You could lose all your money really quickly. To avoid this, you could go on margin. That means you borrow money to trade. That has the advantage of allowing you to lose more money than you have even faster. If it isn't fast enough for you, options are an even quicker way. Too bad you can't trade options in penny stocks, on margin, of course. That would give a new meaning to "Efficient Markets," but I digress.

Can you make money on day-trading? My short answer is "I don't know." Can you lose money day-trading? Think about the things I've mentioned, and you can answer that yourself.