The DIY Investor

Originally published on SmartMoney, August 28, 2012.

Can workers fight the weak economy by becoming full-time investors?

Carter Edson had all his ducks in a row for an ideal retirement. The Vietnam veteran had fully paid off and renovated his four-bedroom home, bought a couple of new cars and retired all his other debts. His retirement savings had hit a cool million. Another three years as an energy researcher, and he'd be ready to log more time on the golf course and take his wife to Paris. All in all, life was looking pretty good on Edson's Dixon, Calif., cul-de-sac -- in the middle of 2007.

All this, of course, was before his family joined the ranks of those who took it on the chin in the Great Recession. Within a year, changes at his job had prompted Edson to retire earlier than he'd planned; then his daughter, recently divorced and unemployed, moved home with her two young children. Edson's nest egg might have been able to absorb his own early retirement, he says, but it didn't budget for diapers, preschool tuition or medical coverage for three more people. Suddenly, the 64-year-old found himself scrambling to make another $2,000 a month. And yet, even with the economy stuck in the depths, Edson didn't bother looking for a job. Instead, he entertained a notion that surprised his family and even himself -- to borrow $100,000 against his house and open a stock-trading account.

A gregarious guy who's old enough to remember Dwight Eisenhower, Edson didn't fit anyone's stereotype of a computer-addicted, stay-at-home stock trader. And yet the more he mulled the idea, the more it seemed like a decent way for a smart person to make some money. His golf buddies had talked about their do-it-yourself trading successes, and Edson himself had made a nice chunk of dough off his own picks during the tech boom. After a few weeks of hunting for good stock ideas, he took the plunge -- and promptly lost thousands of dollars on at least three occasions by hitting BUY when he meant to hit SELL. The experience awakened all his old misgivings about playing the market. "It went against every instinct I had as a child of Depression-era parents," says Edson. "But I was backed into a corner."

Since the primal trauma of the financial crisis, the average joe investor has been playing it safe with his portfolio, avoiding playing the markets even if it means missing out on a rally. And conventional wisdom suggests that people whose employment outlook is rocky should be even more cautious, avoiding risk to protect their savings. Meanwhile, a small but growing subset of investors is bucking not only conventional wisdom but, some critics would say, common sense. These folks have raided their savings, pooled their buyouts -- even borrowed money -- to invest in the very markets that helped threaten their retirement dreams and livelihoods. While more than half of Americans surveyed in a Prudential study last year said they had lost faith in the market, these intrepid investors are doubling down on it. They're deploying their cash full-time -- in some cases, trading far more often than they ever have before -- and trying to pay the bills with their winnings.

Nobody tracks exactly how many do-it-yourself investors there are, or how many of the 23.2 million Americans broadly classified by the Bureau of Labor Statistics as unemployed are dabbling in this field. But some other statistics offer clues. The number of active traders, defined by research firm Aite Group as investors who place at least 36 trades a year, has increased 22 percent since 2008 -- adding 1.2 million people to their ranks despite a fear-inducing market climate. Investors who have brokerage accounts are also "self-directing" a larger share of their assets, analysts say, doing without the services of a full-time middleman. And some of these investors have taken themselves to boot camp. Brokerage giant Charles Schwab says attendance at its seminars for active traders doubled from 2008 to 2011.

In many instances, putting on a day-trader's hat represents a calculated financial choice. For some, it's a stopgap until they find more secure work. When Bob Stammers, now director of education at CFA Institute, a nonprofit group of investment professionals, taught trading courses from 2008 to 2010, he says many of the attendees were unemployed professionals. "Investing was one of the unique situations where they could possibly make as much money as they were before," Stammers says. And trading can remain appealing even for those who've found new work, since many have taken a pay cut. The average earnings loss during the past recession -- 18 percent -- has been the worst since 1984, according to a paper by Princeton economics professor Henry Farber. As the economy improves, some of these new investors aren't so sure about returning to familiar territory. "If I went back to the corporate world, it would limit my income," says Patrick Valle, who began trading options after losing a banking job in 2009.

Of course, investing is anything but a sure shot. In fact, the idea of unemployed clients tapping carefully planned-out nest eggs to invest makes most financial advisers cringe. Mag Black-Scott, head of Beverly Hills Wealth Management, says some of her clients who have taken a buyout want to sink it into cheap real estate they can rent out for income, a move she says is "fraught with risk." The reaction is even more visceral when it comes to day trading. Only about 1 percent of traders are consistently profitable over several years, and investors who trade more frequently tend to underperform the market, according to Brad Barber, a finance professor at the UC Davis Graduate School of Management who has done extensive research on the issue. Trading more also generates more commissions and fees, hurting even those who turn a profit. Those running trading seminars don't refute such statistics. "Even with the basics of a plan in place, it does not guarantee success," says Merlin Rothfeld, an instructor for Irvine, Calif.-based Online Trading Academy, one of the largest players in the training field, which claims 29,000 graduates and generated $62 million in global revenue last year.

That said, a very tiny minority can make a good chunk of money. And consciously or unconsciously, this whole cadre has joined the handful of legendary investors -- professionals like Warren Buffett -- who swoop in when others are fleeing for the exits. Whether that swoop will end in a gentle landing or a wipeout remains to be seen.

The Options Whiz


If anyone knew better than to start day-trading, it was Patrick Valle. Several of his friends lost their shirts after the tech boom, and a career as a compliance officer at a major bank taught him how tricky the markets could be. That bank, as fate would have it, was Washington Mutual -- and as it fell apart during the financial crisis, Valle knew he'd need a plan B. When his job finally fell under the ax, he took a leap of faith, moving back into his old bedroom in his parents' Orange County, Calif., home, at the embarrassment-inducing age of 40, so he could use his severance pay to launch a career as a trader.

In his last days at WaMu, Valle started trying to learn how to play the market in a very different way, by trading options. Options come in a bewildering range of varieties, but they all serve the same function: They give their owner the right to buy or sell any asset, from stocks to commodities, at a specified time at a pre-specified price. Options offer a way to make money even when an asset's price falls, and they've become more popular with mainstream investors since the crash. TD Ameritrade, for example, says derivatives, including options, now represent 35 percent of its trading volume, up from 20 percent at the end of 2009. But options also involve complicated calculations of probability, and investing pros say they can easily lose money, especially in the hands of the inexperienced. Steve Quirk, senior VP of TD Ameritrade's trader group, says newbie option investors frequently buy positions that are too big -- not realizing how much they could lose -- and hold them too long. (Straight-up stock traders make similar mistakes, Quirk is quick to note.)

For most newcomers, the learning curve is steep; the jargon alone, says Valle, is "complete gibberish." (Think "butterflies" and "iron condors," to name two examples.) In Valle's case, he took no fewer than 60 courses and webinars over the course of his first year, flying around the country from traders' expos in Las Vegas to an overnight class in the financial hotbed of...Mobile, Ala. And once he figured out which strategy he wanted to pursue, he spent six months trying to understand the logistics of it, practicing through trial and error on tiny trades. In all, he spent $40,000, almost a third of his seed money. Even that wasn't enough to insure him against trouble: After the flash crash of 2010, Valle ended the day down more than $10,000 -- a lot compared with his typical day, when his loss or gain tops out at $1,000. "It made my heart skip a beat," says Valle.

Since then, Valle has settled into a calmer routine -- one he frequently practices from a Starbucks, since the alternative is working in his bedroom. He specializes in those iron condors, a maneuver that involves owning four different options on the same stock at the same time, improving his odds of making a little money regardless of how the stock moves. To cushion himself, he leaves as much as half the portfolio in cash. And he keeps a mobile phone within reach in case his trading software freezes. Indeed, Valle has now gained more than just confidence; he recently earned a license as a registered investment adviser -- with the aim of investing other people's money in options.

But while his confidence is high, so is his anxiety level. Valle finds himself putting in hours that would have seemed unfathomably long to him before -- staying up until 2 a.m., for example, to get a heads-up on action in the European markets. Andrew Menaker, a San Francisco psychologist who works with traders, says that kind of behavior can start a vicious cycle that can hurt an investor's returns: "Lack of sleep alters the way we assess risk," he explains. Of course, Menaker adds, having to live off of your winnings just adds to the stress. Valle says he recently took up boxing to work off the pressure. "There are thousands of ways to lose money," he says. And there aren't many people he can confide in: His career alarms his parents so much that he avoids discussing it with them. That makes it all the more important, he says, that he attain one of his next financial goals: buying his own home.

Stocks and Grandkids


Waking at 6 a.m., Pacific time, Edson turns on his computer, firing up multiple screens while waiting for the market to open. The action takes place not in his home office, but in the dining room -- Edson keeps his desk there so he can keep an eye on his grandchildren as they play in the living room. Sometimes the kids crawl onto his lap, mesmerized by the colorful graphs and numbers blinking on his screens. They may be adorable, but cuteness can be expensive: On a couple of occasions, the distractions have led Edson to make costly mistakes, such as inadvertently hitting that BUY key -- a serious blunder for a would-be market timer. (He now has a cheat sheet of keyboard shortcuts.)

Unlike Valle, Edson didn't plunge into intensive training to learn how to trade; if anything, he looked to the past. He started by combing old statements from his retirement portfolio and zeroing in on stocks that he'd become familiar with, like casino operator Las Vegas Sands and semiconductor maker Atmel, which he had owned during the tech boom. From Edson's point of view, the financial crisis had a bright side: These stocks, which he already liked, traded at long-time lows. He decided to keep a portfolio of just five or six stocks that he'd watch closely, buying on dips and selling when they surged, acting as what the pros call a swing or momentum trader. That also meant, though, that Edson would sometimes wind up trading more frequently than he'd intended to if one of his stocks had a particularly volatile day. He knew he'd crossed a line on the day his brokerage informed him that he qualified as a day trader. Getting that label, Edson says, felt like "the kiss of death."

Edson's ominous feeling isn't totally off-base. According to Barber, the professor who studies investors' trading habits, the losses, taxes and expenses associated with overactive trading cost investors as much as three percentage points a year -- enough losses to mean that, in most cases, they'd do better just buying index funds. The good news, experts say, is that trading relatively few stocks, as Edson does, can offset some of those disadvantages. Indeed, some mutual fund managers have argued that they've earned better returns by holding on to such so-called concentrated portfolios. "People who jump from strategy to strategy tend to do worse than those who stick to one or a few," says Javier Paz, a senior analyst at Aite Group who also traded professionally for more than a decade.

Then again, a concentrated portfolio can also concentrate your losses. Early on, Edson lost $12,000 in a single day, thanks to a horrific earnings report for Las Vegas Sands. But at least days like that have been relatively rare. Edson says that over the past four years, his trading has provided some much-needed financial breathing room; on one occasion, he made $2,000 in a day by buying and selling a volatile energy stock, and used it to finance a badly needed car repair. Today, he has paid off 40 percent of his original loan and made enough to rent his daughter a house down the block, to help her get on her feet as she starts a new job. With the market more volatile of late, he's trading a little less: Lately, he turns on the computer in the morning to check on Atmel, does a quick search for any other "slow and steady" stock opportunities, and backs away. "I don't have the expertise" to sort through Europe's debt drama, Edson says.

The Impulsive Trader


It's an internal struggle that gives James Anderson angst almost every day -- the choice between selling a position and banking his profits, or staying a bit longer for the chance to earn a bit more. And time after time, it comes back to bite him, especially when his winning streaks are cut short by harsh losses. Investing roughly equal amounts in stocks and options, Anderson once gained $150,000 over a three-month stretch; he also lost $24,000 in a single week. The instability is ironic, given what Anderson used to do for a living: He was a geologist, testing soil at California construction sites to make sure the buildings wouldn't imitate the Leaning Tower of Pisa.

The housing market implosion cost Anderson his job in 2009, and not long afterward he attended ProTrader, the most popular course at the Online Trading Academy. Along with other wannabes, Anderson was immersed for a week in interpreting economic indicators, using trading platforms and learning to read technical charts. Intrigued, he even worked with an independent investing coach via phone, at $1,500 a month, though he eventually felt frustrated with the attention he wasn't getting. (During one conversation, Anderson says of the coach, "I think he was actually shoveling snow.") But for all his training, Anderson says, he still struggles to grasp some of the behavioral rules of being a good trader. His instructors urged their students to set target prices -- specific price points at which to sell their positions. Still, Anderson says he often abandons that key guideline in the heat of the moment. "It's about mastering the mental game," Anderson says, admitting that he isn't there yet.

Psychologists and trading experts say that emotional pitfalls like Anderson's are common. Denise Shull, a former professional trader who now coaches other investors, says newbies often find themselves unable to walk away from their screens, convinced that they'll miss the greatest trade of their lifetime if they leave. And many academic studies have shown that, for similar reasons, many traders are unable to pull the trigger and sell once their investments start losing money. Paz, the Aite Group analyst, says that one of the most important learning processes for traders is to use virtual or demo accounts to "condition their mind" to trade mechanically rather than emotionally.

But temperament is hard to teach, and Anderson says he's not likely to become a cool-headed rationalist. For now, he's continuing to toggle between elation and self-flagellation. As recently as January, he was running out of money for basics like rent. The market's spring rally put him into the black, but within weeks, Anderson found himself on the wrong side of several trades -- including Facebook's initial public offering, which he bought even after telling friends not to go near it. ("I thought it was going somewhere," he says softly.) Despite the nagging feeling he should take a break, Anderson can't give up the market. When talking about stocks, he says, "I sound like a religious fanatic."

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