The Evolution of Day Trading - dummies

The Evolution of Day Trading

With the advent of the telegraph, stocktraders could receive daily price quotes. Many cities had bucket shops — storefront businesses where traders could bet on changes in stock and commodity prices. They weren’t buying the security itself, but were instead placing bets against others. These schemes were highly prone to manipulation and fraud, and they were wiped out after the stock market crash of 1929.

After the 1929 crash, small investors could trade off the ticker tape, which was a printout of price changes sent by telegraph, or wire. They would normally do this by going down to their brokerage firm, sitting in a conference room, and placing orders based on the changes they saw on the tape. Really serious traders could get a wire installed in their own offices, but the costs were prohibitive for most individual investors. In any event, traders still had to place their orders through a broker rather than having direct access to the market, so they couldn’t count on timely execution.

Another reason there was so little day trading back then is that all brokerage firms charged the same commissions until 1975. That year, the Securities and Exchange Commission (SEC) ruled that this amounted to price fixing. Brokers could then compete on their commissions. Some brokerage firms began allowing customers to trade stock at discount commission rates, which made active trading more profitable. (Some brokerage firms don’t even charge commissions anymore — they get money from you in other ways, though.)

The system of trading off the ticker tape more or less persisted until the stock market crash of 1987. Flooded with orders, brokerage firms took care of their biggest customers first and pushed the smallest trades to the bottom of the pile. After the crash, the exchanges and the SEC made several changes that would reduce the chances of another crash and improve execution if one were to happen. One of those changes was the Small Order Entry System, often known as SOES, which gave orders of 1,000 shares or less priority over larger orders.

Then, in the 1990s, Internet access became widely available, and several networks started giving small traders direct access to price quotes and trading activities. This meant that traders could place orders on the same footing as the brokers they once had to work through. In fact, thanks to the SOES, the small traders had an advantage: They could place orders and then sell the stock to the larger firms, locking in a nice profit. Day trading looked like a pretty good way to make a living.

Your library and bookstore might have older books talking about how day traders can make easy money by exploiting SOES. That loophole is long gone, so stick to newer guides.

In 2000, the Small Order Execution System (SOES) was changed to eliminate the small traders’ advantage, but few of them cared right away. More and more discount brokerage firms offered Internet trading while Internet stocks became wildly popular. No one needed SOES to make profits when and Webvan were going up in price every day. But then reality caught up with the technology industry, and the market for those stocks cratered in 2000.

We’re now in a new era, with new trading practices and new regulation.