Can't Keep A Good Day Trader Down Online brokers like Charles Schwab, E*Trade, and Ameritrade may be suffering, but day traders are still partying like it's 1999.
By Nelson D. Schwartz

(FORTUNE Magazine) – If it had been up to her parents, Nancy Xiong would have gone straight to dental school after graduating from New York University. But instead of learning how to fill cavities, prick gums, and perform root canals, the 23-year-old Xiong spends her days in front of a flickering computer screen in the midtown Manhattan offices of Tradescape, buying and selling stocks as if she were playing a video game. Xiong, you see, is a professional day trader. And it isn't just her folks who might find her career choice a little, well, curious. Day trading? Didn't that, like, die a violent death last year after Wall Street fell out of love with dot-coms and the Nasdaq composite came to resemble a Nascar pileup? With the possible exception of Pets.com's Sock Puppet and the Y2K bug, it's hard to imagine something more hopelessly 1999.

So can it be that day traders are actually staging a comeback? Well, not really. The truth is, they never went away--at least not the hard-core ones. Indeed, by certain measures, they're doing better than ever, accounting for an increasing share of overall online trading. "Everybody talks about the day traders' getting killed with the Internet blowing up, but that's not true at all," says Greg Smith, who follows the brokerage industry for J.P. Morgan H&Q.

That's not to say the world of online trading hasn't undergone a fair amount of upheaval since the glory days of 1999 and early 2000. The biggest change is that the amateurs or occasional players--the doctor who used to execute a quick trade between patients, the lawyer who'd buy 100 shares of Cisco on the way to court--have quit the field. Their lack of clicking has meant a licking for prominent brokerages like Charles Schwab, Ameritrade, and E*Trade. Indeed, late last month, in a drastic effort to cut costs, Schwab asked roughly half its 30,000 employees to go ahead and take Fridays off--without pay. Ameritrade and E*Trade have also gotten whacked, losing more than 60% of their market value over the past 18 months.

But for full-time day traders and the firms that cater to them, things are surprisingly peachy. The number of day traders nationwide has held steady, at about 50,000, over the past year. And in many respects, they are a more powerful force in the market than they were at the height of the Nasdaq bubble. While trading by occasional players (15 to 40 transactions a year) dropped 37% in 2000, day traders increased their activity by 55%, according to analyst Amy Butte of Bear Stearns. These trigger-happy types now perform an average of 44 trades a day--about one every nine minutes--and represent a stunning 81% of total online retail trades. In fact, Tradescape, where Nancy Xiong does her thing, recently accounted for about 7% of the Nasdaq's average daily volume. "Day traders are a force to be reckoned with," says Butte. "Wall Street is going to have to take them seriously."

There are signs the big institutions are doing just that, investing hundreds of millions in a bid to cash in on this lucrative niche. Although Charles Schwab's focus is still the buy-and-hold investor and the occasional trader, its $488 million purchase of online brokerage and technology firm CyBerCorp. last year has made it a major player in the day-trading world. For its part, E*Trade is partnering with A.B. Watley, a New York firm that creates software platforms for active traders.

At the same time, old-line Wall Street firms like Salomon Smith Barney and Morgan Stanley have bought stakes in Tradescape, much of whose technology is more advanced than what their own professional trading desks use. And while some Wall Street pros still regard day traders as lucky amateurs at best and declasse speculators at worst, executives at Deutsche Bank recently approached some of Tradescape's most successful traders about coming to work for the German financial giant as--go figure--money managers.

What does all this mean for the rest of us? More than you might think. As day traders pile in when the market rallies or bail out when it dives, the volatility that's been a hallmark of this market will continue, perhaps even worsen. Just look at what happened on Jan. 3, when the Federal Reserve stunned investors with a surprise half-point rate cut. Within seconds of the Fed's move, traders at shops like Tradescape hit the buy button, which helps explain how the Nasdaq was able to jump 244 points in just 30 minutes. For young traders like Xiong, Jan. 3 has become the stuff of legend, the day many of them pocketed $10,000 or more in profits.

Such big scores, combined with new software tools that make trading easier from home, are a big reason for day trading's lingering appeal. And if you're interested in learning how to do it, there are plenty of gurus willing to teach you. "The days are over when you called your broker and bought a golden blue chip," trading teacher-cum-evangelist Toni Turner told a standing-room-only crowd of eager novices on a recent Saturday morning in downtown Orlando. Turner's approach is called swing trading--making money on price swings over the course of days rather than minutes--and for Turner's 35 students, each of whom has paid $595 for this one-day session, it sure beats the old-fashioned buy-and-hold approach. In fact, Turner tells her class, swing trading is "less risky than buy and hold." That's certainly debatable. But as the proliferation of classes by Turner and others shows, the day trader's dream of easy money and short hours is very much alive and well.

Exactly a year ago, FORTUNE looked at the bizarre world of day traders like Adam Mesh, an unshaven, T-shirt-clad 24-year-old who, in just one day, bought and sold nearly 10,000 shares of a company he'd never heard of before. (See "Meet the New Market Makers" in the fortune.com archive.) Today, not only is Mesh still at Tradescape, but he and three partners have formed their own firm, Chimera Capital, hiring 45 associates as proprietary traders. Mesh and his partners provide the initial capital stake and then split any eventual profits with the firm's even younger newcomers, many of whom are recent grads of the University of Michigan, Mesh's alma mater. This unlikely fraternity (so far they're all male, although Mesh insists they'd be thrilled to find a female trader) now possess roughly $2 million in capital and recently traded more than 5 million shares on a single day.

Evan Seidenstein was still in Ann Arbor last spring when he decided to join Mesh's group, even though he had interviewed for positions with traditional firms like Salomon Smith Barney. "I knew that if I didn't give it a shot I would regret it for the rest of my life," says Seidenstein, who has eked out a gain for the past 62 straight trading days. The profits aren't huge--$2,000 to $4,000 a day--but they should enable Seidenstein to earn more than he would if he had taken a job as a junior number cruncher on Wall Street.

Of course, making money as a day trader is a lot harder than it seems when you're hanging around kids like Seidenstein (see box). The learning curve for a day trader is steep, Mesh says. Five of his traders are still down $30,000 each after their first few months, but he remains confident that they will eventually catch on and recoup their losses.

Like Seidenstein, Nancy Xiong missed out on the euphoria of late 1999 and early 2000, when day traders confused luck with trading savvy. A senior at NYU, Xiong had just completed her exams for dental school last August when her friend David Kuang invited her to join him and ten friends at Tradescape. Kuang, who graduated from MIT in 1995 with a degree in finance and economics, has been day trading full-time since 1997; he claims to have earned over $10 million last year. In any case, he has put up about $400,000 to help his friends get started as day traders, training them to look for what he calls "unsustainable price movements" and other small signals that suggest when the time is right to jump in for a quick gain. A rally in Nasdaq futures after a sharp selloff, for example, bodes well for a rapid rise in stocks like Juniper Networks and Broadcom, which closely track the Nasdaq index. On the other hand, a big inflow of sell orders aimed at a particular stock presents an opportunity to short--that is, to sell borrowed shares in a bet that the stock will head south. Unlike Mesh, Kuang says he lets his friends pocket 100% of the profits, and he adds that Nancy Xiong is on track to earn more in 2001 than a first-year MBA.

While people like Kuang and Xiong keep the day-trading faith, it's clear that the rest of us are no longer as engaged in what industry experts call "recreational trading." Occasional traders took a major step back after the Nasdaq peaked in March, and they have yet to return in force. Bear Stearns' Butte estimates that this group went from doing 25 trades a month at the beginning of 2000 to just under 16 in the final quarter. Occasional traders form the bedrock of Ameritrade's and E*Trade's customer base, which is why they've been hammered. Schwab has been clobbered as well, but it's much more than just an online broker, garnering over half its revenues from businesses that aren't related to trading, like fee-based asset management. That should help the company in the next few months, says Richard Strauss of Goldman Sachs, especially as its radical cost-cutting measures take hold.

The outlook for pure plays like Ameritrade and CSFBdirect (formerly DLJdirect) is a lot bleaker. "They could muddle through, but I think the majority of these companies are toast," says Strauss. To make matters worse, Ameritrade and E*Trade are expected to spend a combined $630 million on marketing this year, flooding the airwaves with ads in a desperate search for new customers. "Some of it isn't even marketing--it's just buying accounts," Strauss says. Indeed, both E*Trade and Ameritrade hand out $75 to people who open an account with $1,000 or more.

E*Trade, it should be noted, is trying to branch out and become what it calls an "online diversified financial-services company," offering mortgages and CDs through its E*Trade Bank unit, along with insurance and mutual funds. It's still too early to know whether E*Trade's efforts will succeed, but they have helped its stock rally a bit recently. In the end, however, just about everyone expects the e-brokers to either merge or be absorbed by larger financial services.

Firms that specialize in the day-trading niche, though, aren't worrying about down markets. Omar Amanat, the 28-year-old CEO of Tradescape, says his firm booked revenues of more than $140 million in 2000, up from just $25 million in 1999. And during the fourth quarter of 2000, when the Nasdaq was plunging, Tradescape's average daily trading volume was up nearly 50%. "It doesn't matter whether the market is up or down," says Amanat. "All the day traders want is volatility."

If the trend continues, day-trading firms, once considered as ephemeral as the stock bubble they helped create, may outlive E*Trade, Ameritrade, and the rest of the once hyped-to-the-hilt online brokerages. That would pretty much guarantee that Nancy Xiong will never go to dental school.

FEEDBACK: nschwartz@fortunemail.com