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Commentary
In defense of day traders
SAN
FRANCISCO (CBS.MW) -- Today I’m going to come to the defense of one of
America’s most misunderstood and maligned minority groups -- day traders.
When
the NASDAQ was at its frothy peak last March, the media blamed day traders for
driving up stocks beyond any rational value. Then when the NASDAQ plunged in
April and May, day-traders were blamed for panic selling in response to margin
calls.
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"If
you're a day trader, you're playing a risky game all right, but
it's a game of skill. Over the long run if you make or lose
money at it, you'll have your skill to thank or to blame."
Donald
Luskin,
MetaMarkets
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The
media has always had it in for day traders. Before the NASDAQ crash, the
standard treatment was the brief but tantalizing success story followed by
condescending advice about how day trading is not real investing. But in the
post-crash world, there's always a scare story about someone who gave up a
yuppie job to day-trade full time, got blown out and now lives in a grocery
cart, because day trading is nothing more than gambling.
I’m
a mutual fund manager, and day-trading isn’t my usual line of work. But
sometimes there’s an opportunity to do it -- should I feel guilty? When I
day-trade, am I no better than a gambler? Should I join a 12-step program, or
hide my computer in a brown paper bag and sneak a few trades when no one is
looking?
What
about people who day-trade all day every day (if there are any of them left at
this point) -- should they feel guilty?
My
advice to day traders -- part-time and full-time -- is to keep doing it as long
as you think you can make money at it, and as long as you can stand the risk
along the way. And don't be ashamed of it: day-trading is real investing, and it
is not just gambling. And don't let the moralizing media tell you otherwise.
Think
about it. The difference between investing and gambling can be summed up as:
gambling isn't smart, and depends on being lucky -- while investing depends on
being smart (but being lucky never hurts).
More
formally: investing is putting your money at risk in the rational expectation
that you will earn a return. Luck may be involved. But there’s nothing in that
definition of investing that says anything about the length of the holding
period. It doesn’t matter whether the money is at risk for a Buffet-like
eternity or for just five minutes.
If
short-term investing isn’t gambling, should it be called
"speculation" instead? No--"speculation" is a just a
put-down that has no real meaning. If the only difference between long-term and
short-term investing is the length of the holding period, then let's just call
short-term investing "short-term investing," because that's what it
is.
It
doesn't matter to this definition of investing whether you make a profit or not.
We're defining "investment," not "successful investment."
And it doesn’t matter whether you use leverage or not.
What
does matter is that you put your money at risk rationally -- that you have a
reason to believe that you will earn a positive return. Gambling, on the other
hand, is putting your money at risk in the hopes of earning a return, but with
no rational basis.
State
lotteries are a perfect example of pure gambling. You know that the odds are
stacked against you, because only about half the money contributed is paid out
to the winners (the rest is the "house take"). And there is no
possible way you can apply any knowledge or skill to make your odds any better.
But you buy a ticket anyway because you just hope you will win--and perhaps you
tell yourself that the worst thing that can happen is you'll lose a dollar,
while you might win millions.
Poker,
on the other hand is not gambling. If you are a skilled player, poker is a form
of investing because you put money at risk with the rational expectation of
earning a return. Even if you are an unskilled player, the possibility of
becoming skilled through study or experience is always an option for you. If you
choose to remain unskilled and play anyway, then you choose to treat poker as
gambling -- but that does not make the game itself into a gambling game.
Day-trading
is like poker, at least if you take it seriously. It is a form of investing
because you put money at risk with the rational expectation of earning a return.
The
techniques used by day traders may be very different than the classical
fundamental analysis used by many long-term investors. They may rely on
technical indicators, momentum, or just the gut-feel of an experienced trader.
But none of those techniques are inherently any less rational than Graham &
Dodd.
There
is one factor which can transform either poker or day trading from investment to
gambling: costs.
For
example, casinos that sponsor poker games collect a fee from every player for
every hand that is played. If this fee were large enough in relation to
the amount of money being wagered, then even though any player might still hope
to win by luck, even the most skilled player would not rationally expect to win.
The costs turn poker into gambling.
The
impact of costs on day-trading are not trivial. Today's on-line trading
commissions are indeed low, but as a day trader you might trade dozens of times
every day -- and every time you trade you rack up another commission cost. If
the cumulative commission costs are greater than what you can rationally expect
to earn from your day trading skill, then you are gambling -- you're just hoping
to get lucky beyond your skills and overcome the costs. That means that part of
the skill of a good day trader is to control costs, to only execute the trades
that really need to be made and avoid the ones that don't really matter.
So
don't let the moralizing media scare stories get you down. If you're a day
trader, you're playing a risky game all right, but it's a game of skill. Over
the long run if you make or lose money at it, you'll have your skill to thank or
to blame.
And
don’t forget -- as a day trader, you are in very good company.
Specialists on the New York Stock Exchange, market-makers on commodities and
options exchanges, and traders on the desks of every major Wall Street firm are
all day traders -- and they are all highly respected and highly compensated
professionals. The only difference between you and them is that your business
card isn’t as impressive.
Donald
L. Luskin
is CEO of MetaMarkets.com,
Inc., and a portfolio manager of OpenFund (OPENX).
He contributed this commentary to CBS MarketWatch.com.
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