After years of hunkering down, clinging to cash and retrenching to survive the credit crunch themselves, online brokerages are rediscovering their competitive mojo. In a new wave of competition that’s likely a big positive for individual investors, online brokerages are looking for ways to not only lure customers wading back into the stock market but wrest existing investors from other firms. Charles Schwab fires the opening salvo to the latest post-bear-market showdown today when its commission price cuts go into effect. The firm stunned the online brokerage world this month by cutting the price of online trades 31 percent to $8.95 for all its individual-investor customers. … Whether Schwab’s move will trigger an all-out price war among online brokerages is an open question …

And over at the New York Times David Segal stirs the pot: “Day Traders 2.0: Wired, Angry and Loving It.” Yes, they’re jumping back in with the same confidence as before during the roaring dotcom trading era they lived (and died) on adrenaline and

“the Nasdaq seemed like a casino built by morons and a chimp with darts could pick winners. You would hear about these guys — nearly all of them were guys — and wonder: Could anyone make a living this way? And if the answer was yes, why were the rest of us suckers still holding down regular jobs?” Confidence? No, overconfidence … and that’s a big problem that day traders cannot see.”

In fact overconvidence is the main reason day traders cannot make a living. To be blunt, they’re gamblers destined to lose. Why? Read Jeff Sommer’s article in the NY Times : “How Men’s Overconfidence Hurts Them as Investors. Let’s cut to the chase: Sommers mentions the classic studies of Barber and Odean of the University of California: Their bottom line: “Overconfident investors are going to be interpreting what’s going on around them and feeling they are able make decisions that they’re really not equipped to make.”

We’ve been covering those two U.C. behavioral economists for over a decade. And the results of their research are clear and convincing. They studied 65,000 American investors and the entire market of investors in Taiwan, and the bottom line is simple: “The More You Trade, The Less You Earn.” Transaction costs, taxes and commissions eat up the profits of day traders. In the more recent Taiwan study the four behavioral finance professors had access to all the records of the Taiwan Stock Exchange (TSE) for the 1995-1999 period. Not just 66,400 randomly selected accounts in Wall Street’s huge database of millions of clients, but all 100 percent of the traders on TSE, including their identities, a total of 925,000 investors. That study confirms what we already know for American daytraders … that market timing and day-trading are game for losers.

The most active traders—a small group equaling about one percent of all traders—actually accounted for over half of all the exchange’s volume. While some traders did make money—after transaction costs were deducted they were net losers. The study actually went much deeper: Listen to this new bit of information about the strange self-sabotaging obsession traders have to lose money: The study separated the traders into six groups depending on their past successes. The researchers wanted to see if past winners repeated. The answer was yes, but at a very high cost:

– Overall, 82% of all the traders lost money, for an average loss of $45 a day.
– Out of 925,000 traders, about 750,000 lost roughly $11,250 each, but …
– The repeaters each made only a net $62,750 a year for all their efforts, time & risk-taking.

Yes, remember, “the more you trade, the less you earn.” Transaction costs, taxes and commissions eat up the profits of day traders. American daytraders beware: Market timing and day-trading are game for losers.

Without that Step One admission, Wall Street’s addicts just keep ruining everything in sight, not just themselves, their families and friends, but American capitalism, democracy and the global economy, as we saw in the recent subprime credit meltdown. Addiction and addicts are easy to spot. Years ago I worked professionally with about 300 recovering addicts and alcoholics from Betty Ford and other centers. Here’s how USAToday’s editors see Wall Street’s out-of-control disease today:

Once upon a time, Wall Street was about providing services to institutional clients. It helped them raise capital through lending, and the underwriting of stocks and bonds. It helped them manage their assets by advising them on what to buy and what not to buy. These days, Wall Street has come to resemble a vast and sophisticated gambling operation aimed at making fast profits and paying out fat bonuses. Its investment banks place bets with both their own money and that of clients. And, not infrequently, they make money by taking what might be considered contradictory positions — like the recent disclosure that Goldman Sachs was secretly betting against mortgage products that it promoted in public.

Read the rest of USAToday’s editorial about Wall Street’s loss of its moral compass and addictive behavior. But what really got my attention was Scott Garrett’s (R-NJ) “Opposing View” editorial on GOP talking points: “Don’t Restrict Innovation: Subprime mortgages, not in-house trading triggered financial crisis.” But what’s “innovation?” When former Fed Chairman Paul Volcker was asked what was the most important financial innovation in the past 20 years? His answer: “The ATM!” But not for Wall Street! They love unregulated free-markets. And they hate the new “Volcker Rule,” separating commencial from investment banking. Wall Street’s idea of “innovation” is the super-secret “high-frequency trading” algorithms, and their unregulated derivatives trading in the $670 trillion global shadow banking system. Innovation? Wall Street’s idea of “innovation” is anything that satisfies Wall Street’s insatiable addiction to gambling and getting rich, as we see in Garrett’s distracting defense:

The goal of financial services regulatory reform must be to achieve financial stability and end taxpayer-funded bailouts. This process should not be viewed as an opportunity to restrict innovation or exact punitive regulations on financial activities that did not cause the crisis. It would be counterproductive, to say the least, if in our efforts to ameliorate so-called systemic risk, we advance policies that take away the ability of so many firms across all sectors of our economy to responsibly manage their own risks.

Wall Street’s addictive behavior is America’s ”systemic risk.” And yet Garrett offers the same irrational arguments that killed the Glass-Steagall Act back in 1999, a law that for seven decades had protected Main Street Americans by separating the high-risk speculative activities of investment banks from the low-risk activities of commercial banking. Breaking down that wall was one of the major causes of the 2008 subprime credit meltdown that nearly bankrupt Wall Street.

Today Wall Street is still acting like a unrecovered addict. Refuses to surrender. They want to continue gambling at their own casinos, without changing their behavior one bit, without separating high-risk and low-risk banking, without any awareness that, as people in recovery say, “if you keep doing what you’re doing, you’ll keep getting what you got.” Except next time it’ll be far worse. Their “innovation” argument is dangerous, reminds me of unrecovered addicts promising for the upteenth time that they just need “one more for the road,” or “they “got it under control,” or some other contorted reason, anything so they don’t have to change, don’t have to give up their addiction. Bottom line: Wall Street is an addict, innovation is their drug, they are on a coundown to self-destruct, and they’ll take the rest of us with them.

For more, read my DowJones-MarketWatch column on “Financial Innovation: Wall Street’s New ‘Soul-Sickness’ Lacks a Moral Compass.”

The idea of day-trading triggers an instant and automatic flashback to that classic 1974 movie, “The Gambler.” James Caan, plays a brilliant college professor, the ultimate symbol of the “rational man.” Unfortunately, he’s trapped in his addiction to gambling. He’s in hock forty-five grand. Time and again he gets close to paying off his marker. Then he’ll sabotage himself—again. He’ll take a big risk, lay it all back on the line, one more time. To make the big killing. Can’t stop himself. Like all addicts, his disease controls his brain, blinding him to the consequences. Addicts are irrational.

Now he’s drowning in markers. The sharks want him to pay up. He ain’t got it. Keeps betting. Gets deeper in debt. Killers are after his brilliant head. In one tense scene, with the goons closing in, an anxious professor begs his bookie for another loan, to place one more big bet. To bail him out. “Ya know how all gambling addicts are alike?” says the bookie, sitting in his fancy new sports car, looking at the begging gambler: “They all wanna lose!”

The grand delusions of the macho trader

Same with trading stocks. Tell me: Is there really any difference today being an addict and a loser just because the bookie is an online discount broker, mutual funds or some credit card companies all hounding you for your investment dollars, maybe even promising you “free” trades and high returns? The truth is obvious: Wall Street brokers are no different than Vegas—they’re all bookies. Unfortunately, real addicts can’t or won’t hear the warnings: “There’s no such thing as a free lunch.” There’s a “sucker born every minute.”

They’re deaf and blind. They fail to see or just plain ignore all the hidden costs, the time wasted, research costs, margin requirements, lost interest, the stress of chasing good money with bad, and all the mistakes and losses. The addict is blind, can’t see all that. Why? They’re fighting an inner psychological battle, between proving they’re a hero and a winner in a cold, hard, cruel world, while fighting an inner voice that tells them they’re a loser. The rages on—and it’s all in their brains. They’re trapped in the illusion that they can outwit the market, win at the casino, make a killing. This obsession is an old game that keeps putting commissions in brokers’ pockets.

Nothing’s changed since I was publishing my investment newsletter a couple decades ago. To the man, brokers I talked to agreed that on average investor/addicts lasted one-to-two years before the brokers got all their risk capital in fees and commissions. Were the brokers worried? No, there was always a new crop of suckers to take their places. Fortunately, most of the investors wised up eventually—like addicts going through recovery programs. They‘d get out, poorer but wiser, and without the goons threatening to break their legs, or worse.

Still think you got what it takes to be a winning trader?

Do you have the “killer instinct” it takes to be one of those rare traders who makes more than the average of $50,000 a year? The vast majority don’t, and most that do, still lose (remember Wall Street controls the casino’s odds). Here’s a great example. Listen to this Main Street investor who was certain he had the mojo to beat the casino, tried to do it, and finally figured stopped listening to the promises of Wall Street and became a passive investor, and gave up trying to be a hot-shot day-trader. But like the child who just won’t believe his mom when she says don’t touch that iron—he had to try it himself first, and learn the hard way some costly lessons, all by himself.

Listen closely, his story says a lot about the investor’s strange addiction. Today Jack is an information technology manager working in government. A college grad, he’s married with four children, one in college and three in high school with college coming up next. He’s a member of AARP and looking to retire in the near future, even with four kids in college and grad school. Here’s Jack vivid story as he details how even the winners are losers:

“I was day trading for a two-year period back in 2002-2004 when the market slowly moved into recovery after a thirty-month recession. During that period I averaged about a $5,000 a month profit, on an average 24 trades.” Like many traders, he kept detailed trading records, and still has them, as a reminder. “Sounds pretty good, right, so why did I stop? Well, here’s why:”

1. Hidden costs: “That $5,000 was before taxes. And there were no benefits, no vacation, etc.” Going in, most new traders fail to consider all the hidden costs. “Today my job pays about 50% more a month, not counting benefits and perks. Plus, I averaged 24 trades a month at $10 each. That means about 5% of my profit was nicked by my broker.”
2. Playing by their rules. “Tighter restrictions on float of capital, requiring three business day clearing of trades meant I had to adjust to deploying my capital in ‘thirds’ in order to maintain trading funds each day. Sure I could use margin, but that’s both risky and costly. In short, I was undercapitalized.”
3. Relentless Anxiety. This is the big secret no broker will tell you about up front—the killer anxiety takes a big toll on family life and physical health: It’s relentless, day and night, especially if you’re tying to support a family of six: “Unbelievable stress! The impact of a losing day (and there were plenty) was hard to deal with. Over two years I got better at removing emotion from the equation, but it was still very intense. You literally have to be on your game all the time. I wouldn’t even go to the bathroom with a trade ‘on the table’ for fear of missing the move I was waiting for.” Sounds like a living hell.
4. Being a “good” trader is never enough. “All this, and still I was a good trader. Imagine what it’s like for someone who’s lousy at it!” And most naïve investors are lousy at it. “I only failed to make money in two of the months I traded, I even did well in 2002 a horrible year for stocks.”
5. Cheap trades, a pusher’s come-on. Many of today’s cheap trades hucksters are like drug dealers. They know they’ll recover their “investment” later, so they suck in naïve investors with freebies (“25 free trades the first month!”), you’re hooked, then they can skim off profits later. That’s how addicts become losers. Jack warns: “Very few people are going to come to trade with the “holy trinity” of resources necessary to succeed against Street professionals: Capital, Skill, and Temperament. I just reached the point where the relentless pressure to succeed, every single day, was more stress than I could deal with.”
6. The “lazy” solution. “Now here’s the best part of the story. Since then I found a job in the IT field, I’ve moved all my funds into one of those “Lazy’ Portfolios” you write about, and I’ve done very nicely. I am happier, way more relaxed, and I am richer. In the end, that decision turned out to be the ‘best trade’ I ever made.”
7. Retirement planning bonus. And if you really want to fine-tune your retirement plans, Jack added this little bit of advice: “I also use Boston University Professor Larry Kotlikoff’s consumption smoothing software, ESPlanner, for financial planning. It’s a common sense ‘paradigm shifter’ that should be an integral part of every personal toolkit. It allowed me to confirm what I suspected (that we were actually saving too much for retirement) and also to model a better way to draw down our assets.”
8. Bottom line. Jack’s proof that there really is an easier, softer way. Work at a low-stress business or job doing something you love—and forget chasing “cheap” trades and timing the market. You’ll reduce your anxiety, won’t have to be a hero, avoid addiction to timing the market, and no goons (those “voices” in your head!) will be breathing down your neck.

Jack’s bottom line is so simple, promising and exciting: “Now we will be able to retire in five years and a combination of 401K’s and IRA’s and cash accounts (all invested in ‘Lazy Portfolios’), plus Social Security and a guaranteed pension … and we’ll never have to work again!” You heard him, he’ll never have to work again—without betting at the Wall Street casino—and he did it while putting four kids through college! So before you get lured into the trading addiction, remember that brilliant professor in “The Gambler.” His bookie knows all addicts are secretly self-destructive losers, unable to stop. So bookies don’t have to say anything, no warnings because they know the addict won’t hear them anyway, they’re deaf, blind, in denial. Why are they in denial? Remember this: Because addicts are obsessed with a need to disprove they’re losers—that’s the big secret hidden deep in their souls, hidden even from themselves.

FirstPubDate: Mar’07