Bear essentials

Come on -- nobody is saying, "I'm buying Ebay at $200 as a retirement investment."

I think most of them don't know what game they're playing. I disagree with the idea that these are sophisticated investors. There have been a few cases where day traders not only didn't know anything about the company they were trading, they didn't even know what company they were trading, but reacted when some company with a similar ticker symbol sent out a press release.

Why should that make a difference if all you're doing is trying to make a profit on momentum? You think most traders don't understand the gamble they're taking?

Yeah. Just go look at the chat rooms. Or at the trading rooms in particular. In most cases, these people think that if you buy 1,000 shares of a stock at 20, you'll be able to get out at 22. But because of the way the Nasdaq quotation system works, you're likely to have to sell off 100 shares at a time -- and by the time you get out, that stock could be at 12.

Why would you have to sell in lots of 100?

It all depends on how much of a float there is in that stock, and what the market maker is willing to buy or sell. If he's up there for 100 shares, he might say, "If you want to sell that thing at 20, I'll buy 100 shares at 20; my next buy will be at 19.50. And after that I'll buy another 100 shares from you at 19." If you've got 1,000 shares, the stock could be at 17 before you can sell any of it. That's just how it works; it's a really, really complicated card game that goes on very fast.

And why is an individual day trader at a natural disadvantage?

The thing to remember is that these day trading rooms are trying to re-create the trading process that goes on in a trading room at Bear Stearns or Citicorp or Salomon Smith Barney. The people in such a room have no information beyond what's now available to any single person trading on the Web. But they have enormous experience. Some of them have been in there for 10 years trading eighths of a point on a stock. They understand what happens when you take down 10,000 shares of a stock, and they know how to read the intentions of market makers when they start quoting and changing their quotes on a stock.

The people who are getting into this thing for the first time don't have the slightest idea what this is all about. All they know is that this stock has gone from 2 [points] to 2 1/2 to 2 3/4, and they think the damn thing is going up. For all the logic that goes into their investment strategy, it's just a completely random roll of the dice. And the very next second the whole thing could fall apart on them.

But you don't think that the average investor here has some idea that these traps are out there and can respond accordingly?

Absolutely not. The numbers are self-evident. There's no mystery that people got slaughtered in that case of Micros-to-Mainframe. Now every single person who got hurt in that stock got hurt for a different reason. But the common denominator for all of them was that they didn't know what the hell they were doing. Nobody bought that stock believing that once you got into it you couldn't get out of it, and that it was going to fall in half-point increments from 12 bucks a share down to about eight. And while that was going on, the market makers were only willing to buy in lots of 100 shares each, so if you had 1,000 shares of that stock you couldn't sell it to anybody.

But at the same time, some of the saddest stories on the message boards come not from traders following a rising stock but from people who tried to short these stocks.

These are very difficult stocks to short. If you have a very limited float and you try to short the stock, the underwriter can corner it, and you'll get killed. To take one example, we followed the stock of a company called Shopping.com over a six-month period. As it turned out, most of the investors in that stock were clients of the underwriter of the original IPO. They were able to force a high price on the stock, and the short sellers had to cover that.

How closely do you monitor the activities of market makers taking positions like that?

Well, that's my job. I've got three computers on my desk. One's got a Nasdaq Level II screen, one is watching news all the time, and one is watching a Level 1 real-time quote system that has an easier display, so you can see when stocks start to fall out of their historical patterns. And when that happens, we try to figure out why. Sometimes you can tell whether one or another market maker is dominating the pricing in a stock. If you've got a price that's rising, and you've got one market maker continually selling into it, you know he's got some agenda on that stock.

If a significant player were continually selling, wouldn't that tend to drive the price down?

You don't know. He might be trying to stabilize the price. He might have a short position and think it's all gonna fall apart. All you know is that there's an enormous number of potential market makers for each stock, and if one of them is always there on the inside, there's gotta be a reason for it.

Look, I'm just a journalist here. I don't trade in the market or anything like it, but I try to figure out what's going on so I can write about it. Market makers go through this stuff in their sleep. They understand this stuff infinitely better than a journalist would.

But still, you're one of the only journalists to consistently follow the impact of momentum players.

Most people don't do it. It's more fun to hype some stock all the way to the moon, isn't it? People forget that Newtonian physics always prevails.

Do you get a lot of hate mail?

Yeah, you want to hear some?

Sure.

I'm getting more lately because the market is starting to turn. Nobody wants to be reminded of this stuff when things are going against them. Here's one: "You have a lot of opinions. Why are you trying to scare the hell out of everybody? Just shut up!" Here's another one: "You must be a Democrat. You can't handle the success of others. You're part of the growing conspiracy to stifle the market. It's none of your concern if fortunes are won or lost. It's my money. Go home."

As you mentioned, the market has been pretty nasty lately, and the regulatory agencies are starting to put the brakes on some of this volatility. Whatever happened to caveat emptor?

I don't think the market should be policed to prevent this kind of stuff. But I do think there should be a constant public education process in the media. Instead of becoming a cheering section for bull markets, the media would do a better job if we were constantly trying to take the punch bowl away.

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