I
Number fifty Broad Street is an old-fashioned office building just around the corner from the New York Stock Exchange—the sort of place where each floor has several tenants, the elevator creaks, and the doorman gives you a tired look as you walk by. On a mild afternoon in the spring of 1999, forty people—all but two of them male—were sitting in a conference room on the seventeenth floor. There was one black and one Asian. The rest were white. Most looked to be around forty, but a few were in their mid-twenties, and a couple appeared to be of retirement age. They had come from Brooklyn and Queens and Long Island and New Jersey and Westchester—and one hopeful soul from as far as Iowa. The dress code was casual—polo shirts and jeans—but two Hasidic Jews were wearing white shirts, and one stickler had on a suit. Through the open windows, the sound of traffic and sirens wafted in, making it difficult to hear the two men at the front of the room who were describing their experience as professional day traders.
“As soon as I wake up in the morning, I turn on CNBC,” Randy Guttenberg, a balding fellow with a goatee beard, who appeared to be in his early thirties, explained. “I look where the futures are. I listen to what they are talking about, what stocks are in play. And I look to see who the guests are going to be later in the day. Any time I hear that somebody’s coming on CNBC, I say to myself, ‘What’s going on?’ Michael Dell doesn’t speak bad news. Bill Gates doesn’t speak bad news. Every time they speak, they have something good to say. So I buy the stocks.”1 Guttenberg had worked at Lehman Brothers and Prudential Bache Securities. For the past two years, he had rented a desk and a trading terminal at Broadway Trading, the company that had organized the lecture. “I used to trade two or three stocks at a time; now I have ten or twenty stocks on my screen,” he went on. “My time frame in trading can be anything from ten seconds to half a day. Usually, it’s in the five-to-twenty-minute range.”
The other speaker was a beefy young man in a T-shirt and jeans called Barry Slomiak. He had left Charles Schwab, where he was “getting bored to crap,” to become a day trader. “To be honest, I got walloped for six or seven months,” he said. “Then I started making some money. It’s strictly a confidence game. It took time for me to have the confidence to trade a thousand stocks. Yahoo! still scares the crap out of me, because it’s so volatile. If I have some Yahoo! I’m always thinking, ‘How can I get out of it?’ ” A few members of the audience laughed nervously. They had each paid $1,500 for five days of coaching in the art of day trading.
After Guttenberg and Slomiak finished speaking, they took questions. A middle-aged man asked if they ever held on to stocks overnight. “In the beginning, I wouldn’t recommend it,” Guttenberg replied. “You don’t need the extra risk. But when you are making money, sure. These days I tend to hold some positions overnight. Last night I took home E*Trade and Siebert because they had been beaten down so much.” The questioner wasn’t satisfied. He wanted to know the most that Guttenberg had lost by hanging on to stocks overnight. “When they devalued in Brazil, I came in and I was down $70,000,” Guttenberg replied. “It was horrible. I’ve never been down that much.” Around the room there were concerned looks. “Did you sell?” a voice asked. “No, I held on, and I ended up $15,000,” Guttenberg said with a wry smile. “I know that sounds funny, but that’s the way it is sometimes.”
Marc Friedfertig, the founder of Broadway Trading, spoke next. He was a chubby man of medium height, with long dark curly hair and a friendly face. “Liquidity,” he began. “That’s why the stock market is the best place in the world to invest. You can buy at 50 and sell at 49 7/8. Where else can you do that? Is your car liquid? No. If you had to sell it, it could take three hours or three months to get fair value.” Friedfertig set up Broadway Trading in 1995. A former futures trader and a member of the American Stock Exchange, he did his MBA at Columbia and worked at Morgan Stanley and First Boston before recognizing the trading possibilities that deregulation and technology had created. These went well beyond the services offered by firms like E*Trade and Charles Schwab. When a Schwab investor called up a stock quote on his computer, he saw the “bid”—the selling price—and the “ask”—the buying price. But these prices were only indicative. If the customer placed an order, he had to rely on Schwab to get the best price possible from the market makers in that stock. With stocks like Yahoo! and Amazon.com, which gyrated wildly, the actual price could bear little resemblance to the quoted prices.
Firms like Broadway Trading worked differently. Their computers linked traders directly to the Nasdaq market site and to several independent electronic exchanges that had sprung up in recent years, such as Instinet and Island. For any given stock, the trader could see the exact number of shares that were being offered, plus the prices being requested and the identity of the seller. By pressing a few buttons, the trader could accept one of the offers, or post his own offer on the screen for others to consider. For the first time in history, the ordinary investor really could trade alongside the professionals.
The goal of day trading, Friedfertig explained, was to dart in and out of the electronic marketplace, making a series of small profits. Buy at 50. Sell at 50 1/8. Buy at 50 1/8. Sell at 50 1/4. And so on. The two keys to successful day trading were money management and timing. “The number-one reason that people lose is because they don’t know how to control their losses,” Friedfertig said. “If things are working, keep trading. If things are not working, slow down. You’ve gotta be like a great quarterback.” Until they got the hang of things, novices should limit themselves to blocks of 100 shares, priced somewhere between $5 and $55. They should avoid the top twenty movers “because that’s where the sharks are,” and they should always close out their trades if the market turned against them. “People who double up on their losses eventually get buried.”
Listening to Friedfertig’s presentation, day trading seemed like a reasonable way to spend days. It didn’t sound easy—“The first six months are going to be hard, and I’m telling you that now”—but it did sound manageable, like learning a new sport. “So much of trading is about probabilities,” Friedfertig said philosophically. “At any given moment supply and demand can change without you knowing it. Some guy at Fidelity can decide to dump all his Dell. The market is humbling. Everyone has setbacks.” To explain his point, Friedfertig brought up the name of Serge Milman, Broadway Trading’s star trader, a twenty-five-year-old Russian immigrant whom Forbes had featured on its front page a few months previously.2 “Serge makes money nineteen days out of twenty, but when he loses he doesn’t lose much,” Friedfertig said. “The first goal is not to lose money. If you make $500 a day, that’s $125,000 a year. Two hundred dollars a day is $50,000 a year. That’s not too bad.”
The audience members looked dubious. A few looked at their feet. They hadn’t spent $1,500 to learn how to make $50,000 a year. They wanted to be like Serge, who, according to Forbes, had grossed $1.4 million the previous year and netted $800,000 after commissions. They wanted to be like Jeff Cooper, the author of Hit and Run Trading, who had a house in Bel Air and another in Malibu. Friedfertig knew this, of course, but he had to be careful. Lately, day trading had gotten some bad publicity. The attorney general of Massachusetts had sued one of Broadway Trading’s rivals, claiming that it misled its clients about the likelihood of making profits. Arthur Levitt, the chairman of the Securities and Exchange Commission, had inveighed against day trading, warning investors that “investment should be for the long run—not for minutes and hours.”3 Friedfertig resented these attacks. He had written two books on day trading; he considered it a revolutionary development; but he had never claimed it was risk-free. “Nobody should take substantial risks unless you are making money consistently in trading 100 shares,” he warned. “You guys have got to be able to play penny poker, and take it seriously, before you move to the big table.”
II
Ironically, the SEC was partly responsible for the rise of day trading. Until the middle of the 1990s, the big Wall Street firms dominated trading in Nasdaq stocks. In 1993, the Department of Justice launched an investigation, which concluded that the market makers were colluding to gouge the public, often by ignoring their orders. The SEC levied a billion-dollar fine and forced the Wall Street firms to agree to fill any order that improved on the quoted price and to display buy and sell offers from other electronic exchanges. These reforms allowed individual investors to see precisely what prices they were getting, and it also allowed them to trade with each other, rather than through the market makers. All they needed was a Nasdaq Level II trading screen and some trading software, both of which were provided by firms like Broadway Trading.
By early 1999, there were more than sixty day-trading firms, with almost three hundred offices, across the country. The biggest were Momentum Securities, which was based in Houston, and All Tech Investment Group, of Montvale, New Jersey. According to the SEC, the number of people trading full-time at day-trading firms was somewhere between 5,800 and 6,800. There were probably another few thousand people trading at home with software provided by the day-trading firms. Even counting these traders, day trading, properly defined, was the activity of a pretty small group of investors.
The main barrier to becoming a day trader was money. Most day-trading firms asked their customers to deposit between $50,000 and $100,000 before they could start trading. These deposits were necessary because the whole point of day trading was to buy and sell a lot of stocks, which takes a lot of cash. According to the Electronic Traders Association, a trade group for day-trading firms, the typical day trader placed thirty-five trades a day, each for an average of 700 shares. Although the number of day traders was small, the amount of trading they did was enormous. By the start of 1999, day trading accounted for about 15 percent of the total trading volume on the Nasdaq. This was an overall figure. For some Internet stocks, such as America Online and Yahoo!, the percentage was much higher.
Given the entry requirements, day trading was a game for rich people—or middle-income people who had mortgaged their futures. Unfortunately, there were a good number of the latter, drawn in by the prospect of giving up their jobs, their jackets and ties, and making money on their own time. Most day traders were well educated. It took a certain level of intelligence and arrogance to persuade yourself that you could trade successfully against Wall Street professionals who had been doing it all their working lives. Despite the large amounts of money at stake, the day-trading culture was casual. “Shop guys,” the traders who sat shoulder to shoulder at firms like Broadway Trading, tended to be gregarious, swapping war stories, trading strategies, and gorging on pizza. (Some day-trading firms provided free lunch so the traders wouldn’t have to stop trading.) “Remote guys,” the traders who worked from home, were more isolated. They tended to spend a lot of time in chat rooms like mtrader.com and daytraders.com, where they picked up the latest gossip. Some of them frequented TheStreet.com, which had its own day-trading correspondent: Gary Smith, a freelance sportswriter who traded from his Connecticut home.
Like all forms of gambling, day trading was addictive. Some participants compared it to blackjack, others to compulsive video games. “Anyone who has ever played Space Invaders knows the drill,” Steve Bodow, a writer and theater director who wrote about his day-trading experiences for Wired in early 1999, explained. “After a time, the little bastards take up residence behind your eyelids; the crimson bonus saucer floats across your field of vision while you’re in a job interview. Day trading just subs numbers and ticker symbols for the marching pixel-goonies.”4 Some day-trading firms weren’t as honest as Friedfertig about the risks their customers were taking. “If they follow the rules, they’ll succeed,” Sal Giamerese, a day trading coach at an All Tech Investment Group office in Fall Church, Virginia, insisted to The Washington Post. “It’s like golf. If you’re careful about how you place your feet, how you lift the club and follow through, you’ll stand a far better chance of hitting the ball straight than hooking it. The same principle applies to day trading.”5
In a way, the golf analogy was accurate. Like most amateur golfers, the vast majority of day traders did poorly. When the Massachusetts authorities investigated one day-trading firm in their state, they found that sixty-seven out of sixty-eight customers had lost money. Even if their trading strategies worked, day traders often ended up taking heavy losses after paying their hefty trading commissions. As more people got involved, tales of disaster multiplied. A Chicago waiter with no trading experience blew a $200,000 inheritance. A Boston retiree went through $250,000 of his wife’s savings in a few hours. A California bank employee quit his job, borrowed $40,000 on his credit cards to start trading, and promptly lost the lot.
Mark Orrin Barton, a forty-four-year-old Atlanta man, was one of the losers. Barton was typical of the thousands of Americans who had given up their jobs to become day traders. A former chemist, scout leader, and Jehovah’s Witness, he lived in Stockbridge, a modest suburb, with his second wife and two children, but he spent many of his days in the posh Buckhead section, where a number of day-trading firms had offices. Barton began day trading in 1998 at the offices of All-Tech Investments. By April 1999 he had racked up big losses and his account was shut down. In early June, Barton started trading again at the nearby Momentum Securities. He claimed to be worth $750,000 and wrote a check for $87,500 to open an account.
Despite the change of venue, Barton’s trading losses continued. Although Internet stocks were undergoing a correction, he kept buying them, particularly Amazon.com, in the hope of a turnaround. Ignoring the day traders’ dictum, he refused to close out losing positions. In just eight weeks, he lost $105,000—his original stake plus $17,500 that he had borrowed on margin. On Tuesday, July 27, Momentum Securities issued Barton with a margin call: unless he came up with the money he owed, his account would be closed. That night Barton went back to Stockbridge and battered his wife to death with a hammer, bundling her body into a closet. The next day, Momentum informed Barton that a check he had written for $50,000 had bounced. This time, Barton went home and bludgeoned his nine-year-old daughter and twelve-year-old son. After placing their bodies in their beds, with their favorite toys beside them, Barton wrote a suicide note in which he said: “I don’t plan to live very much longer. Just long enough to kill as many of the people that greedily sought my destruction.”6
On Thursday, July 29, Barton put on the baggy shorts that he often wore to trade in and drove to Buckhead. He went first to Momentum Securities and asked for the manager, who, fortunately for him, was out to lunch. Barton walked onto the trading floor, commiserating with a few traders about the market, which was down steeply. “It’s a bad trading day, and it’s about to get worse,” he said, pulling out a .45 automatic and a 9mm pistol.7 He started firing wildly, killing four people and wounding several others. Then he went across the street to All-Tech Investments, where the manager was in his office. After shooting him, Barton walked out onto the trading floor, said, “I certainly hope this doesn’t ruin your trading day,” and shot dead another four people before fleeing.8 A few hours later, police pulled Barton over at a gas station, and he shot himself in the temple.
The Atlanta massacre brought home the risks, the losses, and the anguish of day trading. Harvey Houtkin, the founder of All-Tech Investments, had once referred to day trading as “the best entertainment since television,” but there was nothing entertaining about gullible investors losing their life savings.9 The only people who consistently made money from day trading were Houtkin and his fellow owners of day-trading firms, who raked in enormous trading commissions. Taking the Electronic Traders Association’s own figures, the average day trader bought or sold 6 million shares a year. Assuming that he paid two cents a share to trade, which was common, he spent $120,000 a year in commissions—more money than many day traders had in their accounts to begin with. Given these fees, the common perception that day trading was a relatively cheap business to operate was an illusion. Behind the marketing hype about personal empowerment, day trading was a business that any Wall Street old hand could appreciate: the customers risked their capital; the brokers made the profits.
III
If Barton had been able to hold on for a few more weeks, the massacre might not have happened. Amazon.com’s stock, after falling for months, rebounded strongly in August, and the rest of the Internet sector did likewise. By then, Barton’s shootings had largely disappeared from the media—widely written off as just another homicidal outburst by an angry white male. Barton was undoubtedly a disturbed individual. After the shooting spree, it emerged that he had been the prime suspect in the murder of his first wife and mother-in-law several years earlier. But in some ways he wasn’t so untypical. In his decision to give up his regular career, his fascination with Internet stocks, and his belief that buying and selling stocks was a good way to get rich quickly, he was like countless other Americans.
Day trading, after all, was just an extreme form of online trading, which had developed into a national pastime. More than 5 million American households now had online trading accounts, and many had more than one. Charles Schwab, alone, had almost 6 million customer accounts, and it was adding another 100,000 every month. A third of all retail stock trades were being done online, and the percentage was increasing. In June, TD Waterhouse, the second biggest online brokerage, with almost 2 million accounts, went public in the biggest Internet IPO yet, raising more than $1 billion.
The established Wall Street firms, which had long subsisted on fat commissions, reacted to the growth of online trading by going through a cycle of shock, denial, and, finally, capitulation. In the summer of 1998, Launny Steffens, the vice chairman of Merrill Lynch, described online trading as “a serious threat to Americans’ financial lives.”10 On June 1, 1999, less than twelve months later, Steffens stood alongside David Komansky, Merrill’s chairman, as Komansky announced that the firm’s customers would soon be able to buy and sell stocks online for $29.95—the same price that Schwab charged. “It’s clear that there is a segment of the marketplace that wants access to Merrill Lynch and the markets through online trading,” Komansky said. “We saw that as an inevitable market offer that we had to make.”11
Day traders apart, the online investors could be divided into two groups. The first group, which numbered perhaps 200,000, comprised the most active traders, who bought and sold stocks every day, or almost every day. Many had turned investing into a first or second job. Unlike the day traders, they tended to hold on to stocks for days and weeks, sometimes even months. These people frequented TheStreet.com, RagingBull.com, and other financial Web sites. Many of them used no-frills online brokers, such as Datek, which charged as little as $10 a trade. They accounted for up to three-quarters of all online trades, and they were often responsible for the sudden spikes in Internet stocks. (Some Internet stocks became so volatile that firms like Schwab refused to deal in them.)
The second group of online traders was made up of people who bought and sold stocks on a regular basis, but didn’t devote their lives to the market. This group included the vast majority of individual investors. They tended to favor firms like Schwab and Fidelity, which combined online trading with offices where customers could go and speak with real people. When Fidelity surveyed its online customers it found that they traded, on average, 5.5 times a month, compared with 2.7 times a month before they went online.12 Not surprisingly, Internet veterans tended to trade most actively. Many newcomers reported themselves overwhelmed by all the financial information available online, and 37 percent of them admitted that they based their investment decisions on instinct.
Most online investors were men, but as time progressed more women took up the activity. By the end of 1999, about a third of Fidelity’s new online customers were female. Many of these women learned about the stock market through investment clubs, which had sprung up all over the country. The growth of investment clubs is an aspect of the stock market boom that is often overlooked. In 2000, Robert Putnam, a professor of government at Harvard, published Bowling Alone, in which he claimed that the decline of bowling clubs and other groups where people have traditionally come together reflected an ominous decline in “civic society.”13 Putnam’s was an interesting thesis, and it had some truth to it, but it ignored the proliferation of one type of voluntary association where millions of Americans gathered regularly, talked with each other, and acted in unison on an issue close to their hearts: money. In 1992, there were 7,200 investment clubs listed with the National Association of Investors Corp., a nonprofit organization based in Madison Heights, Michigan; at the start of 1999, there were more than 37,000. By then, the United States contained more investment clubs than movie houses. And this figure only included those investment clubs that had gone to the trouble of listing with the National Association of Investors. Probably half as many again hadn’t bothered.
A typical investment club had about fifteen or twenty members, each of whom put about $40 a month into a kitty, which was then invested in stocks selected by all the members. More than two-thirds of the members of investment clubs were women. The model and inspiration for many of them was the Beardstown Ladies Club, of Beardstown, Illinois, which in 1995 published a best-selling book, The Beardstown Ladies’ Common Sense Investment Guide: How We Beat the Stock Market and How You Can Too. The Beardstown Ladies claimed to have made an annual return of close to 25 percent for a decade. An outside audit later revealed that the actual return was less than 10 percent, but that was after the group had appeared on the Today show and other television programs promoting their homespun approach to investing, which involved buying solid companies at decent prices. Not all of their imitators took such a conservative stance. When The Daily News of Los Angeles held a stock-picking contest for local investment clubs, the Wall Street Women of Granada Hills, a group of local hairdressers, came out on top with a portfolio that included America Online, eBay, EarthLink, and Yahoo!14
There were investment clubs catering to blacks, Asians, college students, and even high school students. The National Association of Investors started a young membership program, with its own newsletter, Young Money Matters. CNBC organized a high school stock-picking contest, with the prize an appearance on its Power Lunch show, and received about 2,500 entries. There were Web sites, books, and summer camps for young investors. In the blighted South Bronx, teachers at Aquinas High School took their pupils on field trips to Wall Street.
As long as the stock market kept going up, few people questioned the underlying premise of all this activity—that buying and selling stocks on a regular basis was a profitable pursuit. Brad M. Barber and Terrance Odean, two economists from the University of California at Davis, did bother to look at the evidence, examining the trading records of a large discount brokerage between 1991 and 1996. During that period the firm’s 12,000 most active investors earned an annual return of 10 percent, compared to 15.3 percent for all customers and 17.1 percent for the market. The main reasons why active traders did badly were commission costs and poor market timing. “Our central message is that trading is hazardous to your health,” Barber and Odean concluded.15 Their study confirmed what many others had shown before: for most people, the best way to invest is to buy a diverse portfolio of stocks, or a mutual fund, then forget about it for a decade or two. The worst way is to trade every day.
The only Americans who remained totally immune to the stock market bug were those too poor or marginalized to be influenced by the dominant culture. It should be noted that this group was a lot bigger than is generally recognized. To talk of a “nation” obsessed with Yahoo! and Amazon.com was to ignore the fact that, despite the growth of a populist stock market culture, stock ownership in the United States remained heavily concentrated among the well-to-do. In 1998, the last year for which reliable figures are available, 48.8 percent of American households owned stocks in some form, up from 31.6 percent in 1989.16 This was a big increase, certainly, but even after a decade and a half of rising stock prices the majority of American families still had no stake in the stock market at all. It is also worth noting that, regardless of the growth of day trading, online trading, and investment clubs, the majority of investors still didn’t possess any individual stocks. In 1998, less than one-fifth of American households owned stock directly—that is, outside of mutual funds and retirement accounts. Most investors stuck to mutual funds. The mania for trading individual stocks, unprecedented as it was, remained a minority pursuit.
IV
In the summer of 1998, three economists published an article in The Journal of Economic Perspectives entitled “Learning from the Behavior of Others: Conformity, Fads, and Informational Cascades.”17 Sushil Bikhchandani, David Hirshleifer, and Ivo Welch tried to explain why very different people often end up doing the same thing, such as wearing the same brand of shoes, watching the same television shows, or putting their money in Internet stocks. The key to such fads, the economists argued, is “social learning”—learning from the actions of others. When faced with a choice of actions, such as deciding whether to buy Yahoo! or eBay at a price equal to several hundred times its revenues, a person can react in one of two ways. The first option is to examine all of the alternatives, weigh up their costs and benefits, and make an independent judgment. “However, this can be costly and time-consuming, so a plausible alternative is to rely on the information of others,” the article explained. “Such influence may take the form of direct communication and discussion with, or observation of, others.”18
Imitating the actions of others is a trait deeply ingrained in many animals, not just humans. The economists speculated that it might be an evolutionary adaptation that has promoted survival by “allowing individuals to take advantage of the hard-won information of others.”19 Whatever the cause, once a few people decide to rely on others rather than thinking for themselves, the behavior can quickly spread. If this happens, the result may be an “informational cascade” in which, ultimately, nobody acts on his or her own judgment. “Public information stops accumulating,” the economists wrote. “Any early preponderance toward adoption or rejection causes subsequent individuals to ignore their private signals, which thus never enter the public pool of knowledge.” The result: “With virtual certainty, all but the first few individuals end up doing the same thing.”20
By the summer of 1999, millions of Americans were trapped in an informational cascade. If they had been confined to a quiet room and asked whether they really believed that Yahoo! was worth more than Texaco, or America Online was worth more than Time Warner, most of them would have said no. But they were not confined to a quiet room. They were living in an environment where their friends and neighbors were buying stocks, Wall Street analysts and journalists were constantly reminding them that stocks were the best of all possible investments, and respected commentators were arguing that the Dow was heading for 20,000, 30,000, or even 40,000. In such an environment, as the sociologist Gustav Le Bon wrote in his classic book The Crowd: A Study of the Popular Mind, an individual “is a grain of sand amid other grains of sand, which the wind stirs up at will.”21
Le Bon was writing during the 1890s, but his description of how people subjugate their own reasoning to the will of the crowd prefigured the work of contemporary economists. “The fact that (individuals) have been transformed into a crowd puts them in possession of a sort of collective mind which makes them feel, think, and act in a manner quite different from that which each individual of them would feel, think, and act were he in a state of isolation,” Le Bon wrote. Once a crowd has formed, it has a natural tendency to go to extremes because “the individuals in the crowd who might possess a personality sufficiently strong to resist the suggestions are too few in number to struggle against the current.”22 Eventually, even the independent-minded give up the fight.
At the end of August, Charles Clough, one of the last remaining bears on Wall Street, announced his forthcoming retirement as Merrill Lynch’s stock strategist. For several years, Clough had been advising investors to keep much of their money in cash and bonds. His cautious stance had become an embarrassment to himself and to his firm. In a recent Wall Street Journal survey of the performance of numerous stock strategists, he had come at the bottom in the one-quarter, one-year, and five-year categories. Clough’s resignation was no surprise. What was surprising was that he had lasted so long. An ordained deacon in the Roman Catholic faith, he said he wanted to spend more time with his family and his church.23