WHAT A DIFFERENCE A DAY TRADER MAKES: DO-IT-YOURSELFERS FUEL ONLINE BUSINESS BOOM AND DRIVE DOWN COSTS

Nineteen months isn’t a heck of a long time, but stock trading on the Internet over that period has created a new way to play the equity markets.

While most investors who use the Internet tend to make a small number of electronic trades each month on the over-the-counter market, a new breed of aggressive traders has emerged. They’re referred to as day traders, since they trade for their own account numerous times a day, creating a booming business that’s providing an increasing number of people — both traders and brokers –with a very good living.

Electronic trading since February 1997 has doubled to about 20% of all trades on Nasdaq from last year, according to the National Association of Securities Dealers. It’s also delivered sharply lower costs and narrower spreads on Nasdaq trades, and brought brisk price competition among the myriad of discount brokerages serving the new players.

As day-trading organizations are not required to register with the NASD — they trade using software and hardware provided by high-tech companies, linked to a registered brokerage or through a brokerage’s system directly — there is no official figure of exactly how many there are. But traders and service providers estimate that there must currently be thousands — if not tens of thousands — of them. And more and more online accounts are opened every day.

traders vs. investors

There’s also an assortment of tax benefits to be had if you qualify as a trader rather than an investor. Robert A. Green, the founder of Green & Company Inc., a New York CPA firm that provides tax and professional services to Internet securities traders, says many people qualify for trader-in-securities tax benefits, but don’t realize it. They’re also unaware of the tax benefits of being classified as a trader — many of which are covered under new provisions in the 1997 Taxpayer Relief Act.

“Traders who elect mark-to-market accounting may deduct an unlimited amount of trading losses as ordinary losses against any other type of their taxable income,” Mr. Green says. “They can also deduct all trading business expenses in full on Schedule C, and trading gains are not subject to self-employment taxes. Traders also maintain the one benefit that investors have — lower long-term capital gains tax rates — if they identify those positions at the time of purchase. In comparison, investors are subject to many limitations on deductions and losses; can only deduct $3,000 of net capital losses per year; and are limited in the types of investment expenses that can be deducted.”

Day traders — many of whom work from home or in a communal trading office — can trade as market-makers and post their limit orders directly on the Nasdaq system. This was made possible in early 1997 when the Securities and Exchange Commission allowed the use of private trading systems known as ECNs or electronic communications networks. That provided much-needed competition to the traditional market-makers, who previously had total control over when Nasdaq orders were posted and filled.

This trading revolution resulted in quoted spreads on Nasdaq stocks falling as much as 41% on average in 1997, which has saved traders and investors tens of billions of dollars, the NASD says.

Also smiling are the myriad of companies that provide the hardware and software allowing traders to make markets and trade — and the discount brokerage houses, which either offer their own online trading systems or have entered into arrangements with other groups to do so.

For many discount brokerages, electronic trading is contributing an ever-increasing percentage of total trading revenue. As such, they’re actively trying to attract new clients by offering lower prices and a better range of services, while making amazing claims as to how quickly their system can execute the trade.

Take Waterhouse Securities. Dennis Azary, assistant manager for its Northwest processing center, says online trading accounts for 40% of its trading revenue, up from 25% a year ago. “And we expect this to rise to 60% of our business in the next two years. A number of our clients are day traders, often buying and selling stock in a matter of minutes. The balance are probably trading as a sideline rather than to make a living and are not motivated to make profits on a daily basis,” he says.

adding 3,000 monthly

Timothy Pimentel, a California-based representative for discount brokerage JB Oxford & Co., says the firm has tens of thousands of online trading clients, and is opening as many as 3,000 new such accounts a month. While not all of these are day-trading accounts, the number reflects the huge swing towards online trading, he says.

George Muniz, the co-founder of Executioner, which provides the technology and services to execute trades for online clients, says it has 700 online traders, the majority of whom are day traders. It is the clearing arm for Southwest Securities, a member of the New York Stock Exchange.

“While day trading is still in its infancy, its growth to date has been remarkable and is set to skyrocket,” Mr. Muniz says. “The demand for the service continues to grow. It is all the more remarkable if you consider that investors have only been able to post their trades directly on the Nasdaq market since the start of 1997.”