INVESTOR ALERT:

Day Trading

State securities regulators are warning investors to be on guard against a rise in affinity group fraud. What is affinity fraud? It’s simple, but the causes that give rise to it are often more complex.

The increasing popularity of stock “day trading” – which has spawned how-to books and pricey day-trading “schools” – should give investors pause, according to an association of state securities regulators.

“For the typical retail investor, day trading isn’t investing; it’s gambling. If you want to gamble, go to Las Vegas; the food is better,” says Philip A. Feigin, executive director of the North American Securities Administrators Association (NASAA). “For sophisticated investors, there’s nothing wrong with day trading per se. We have a problem with firms that are trying to create a mystique about day trading that suggests it’s something for Main Street investors.”

The allure of day trading is easy to understand, says Feigin. “Who wouldn’t want to work at home in front of their computer and retire at 40?” Largely unskeptical media coverage has glamorized day trading, downplaying the risks, says Feigin, who was Colorado’s Securities Commissioner for 10 years. Amazon.com recently advertised no less than three how-to books targeted at electronic day traders. Last spring Forbes magazine featured a youthful day trader on its cover. Cable financial news shows have aired segments on day trading, generating an enormous viewer response.

Several dozen day-trading firms operate around the country and they have thousands of customers, according to media reports. At day-trading firms, investors use computers and proprietary software to make rapid-fire trades, hoping to capitalize on a stock’s momentum. By darting in and out of stocks they hope to lock in profits of pennies per share. They typically close out all their positions by the end of the trading day. Most day traders eschew fundamental research. “Most of them don’t care what kind of business the company’s in; they’re just watching numbers on the computer screen,” notes Feigin.

Last month regulators in Massachusetts brought actions against two day-trading firms, Block Trading and Bright Trading, and other states -- from Texas to Colorado -- are looking at day-trading firms. NASAA has formed a day-trading task force to study the phenomenon. In Massachusetts, regulators sued Texas-based Block Trading, alleging among other things, that the now-bankrupt firm engaged in deceptive advertising that overstated possible profits and played down risks.

State regulators are concerned that many of the novice day traders are given unrealistic expectations. “A mouse and a modem alone won’t make you a successful day trader,” says Peter C. Hildreth, New Hampshire’s Director of Securities and NASAA’s president. “Successful day trading takes hard work, discipline, a strong stomach and luck.”

Regulators say the same message applies to the hundreds of thousands of investors who are actively trading from home using on-line brokerages such as E*Trade, Datek Online and Ameritrade. For regulators, among the issues on-line trading raises is the question of suitability. At traditional brokerage houses, brokers have an obligation to ensure that investments they recommend meet the financial goals of their customers. Says Hildreth: “When you trade on line there’s no one standing between you and the market. No one’s obligated to ensure that the investment is appropriate given your age, income and financial goals.”

To be sure, the Internet is revolutionizing Wall Street, empowering individual investors and leveling the information playing field. The Net has made Wall Street quality research available to investors on Main Street and it has pushed down trading costs. But investors need to watch out, say regulators. Referring to the rock-bottom commissions electronic brokers charge, NASAA President Hildreth cautions: “Just because something’s on sale doesn’t mean you need to buy it.” State regulators have been contacted by day traders or their relatives concerned about the possibility of addiction to day trading. “You can get quite a rush from it -- but you can also end up with a big financial hangover,” says Hildreth.

If you want to day trade, state regulators urge investors to be sure they: check out the day-trading firm with their state securities regulator to see if it’s properly registered and learn if it has a disciplinary history; only invest money they can afford to lose; carefully examine commissions and other fees, including the cost of day-trading seminars that can cost thousands of dollars; carefully read contracts or agreements with the firm; and, finally, be very skeptical about promises of huge returns.

Issued 1999

This publication was compiled by the North American Securities Administrators Association

and the Better Business Bureau and is furnished to you by the Texas State Securities Board.