Day-Traders Beware

A sudden plunge and rebound in the stock market is tantalizing, similar to hearing about a lottery winner. We fantasize about what might have happened if we had been on the floor of the New York Stock Exchange, or on our computer looking for bargain stocks, when Accenture and P&G share prices dropped through the floor. We would have put in a “buy” order at the limit of our credit and made millions when the stock rebounded. However, the market does not work that way, either for actual players or for ordinary schlubs like us.

Many stock traders who made a killing during the 20-minute upheaval on Bungee Thursday will have their trades reversed. According to Julie Creswell, in “The Trades of a Lifetime in 20 Minutes,” The New York Times, at B1 (May 8, 2010), large U.S. stock exchanges intend to untangle the spaghetti and reverse many trades made while the market was in free-fall. For example, the Nasdaq market will look at trades made between 2:40 and 3:00 p.m. on Thursday and reverse stock purchases that deviated 60% or more from the price at the beginning of the period. Traders who were celebrating the buy of a lifetime on Bungee Thursday can look forward to a lifetime of talking about “the one that got away.” The resultant confusion and disruption in the portfolios of institutional and large non-institutional investors can only be imagined. However, few ordinary individual investors will be affected to any great degree.

Unlike Wall Street investors, Main Street investors are largely barred from profiting from big swings in stock prices. By the time stock owners in the hinterlands, like Michigan or Mississippi, hear or read news that would greatly affect a particular stock or industry, arbitrageurs have already soaked up the profits. Even if a day-trader gets lucky, the chances are that most of the profit will be skimmed off by the institutional investors. The game is rigged against the individual investor.

Think of a casino full of slot machines that allow other players to buy into a jackpot. One player hits a jackpot, but when the cherries line up there is a window for other players to buy a piece of the jackpot. A big institutional investor playing a million-dollar machine doesn’t have much to worry about. Very few investors are wealthy enough to buy a significant stake in the jackpot. But an individual who can only afford to play the hundred-dollar slots will see most of the jackpot disappear as institutional investors horn in.

Individual small investors can make money in the stock market, just as some lottery players come out ahead. However, they should realize that the market is rigged against them. This is particularly true if they are trying to make money on short-swing trades. Institutional investors and arbitrageurs will beat out anyone who does not have a seat on an exchange and is not on the spot when news arrives.

The stock market is a good investment because its trend is generally upward, but not for a day-trading small investor. The best strategy is to buy a diverse portfolio of stocks or a selection of mutual funds and hold them. The more trading an individual investor does, the greater the likelihood of loss.

 

John B. Payne, Attorney
Garrison LawHouse, PC
Dearborn, Michigan 313.563.4900
Pittsburgh, Pennsylvania 800.220.7200
law-business.com
 
©2010 John B. Payne, Attorney
 
 
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