Online Stock Trading
By: Doug Jeremiah
UH 3004 Internet Impact
5/3/99
Once an obscure means of trading stocks, online trading has jumped to the forefront of Wall Street. Online trading provides investors with a fast, convenient, secure, and most importantly, affordable way of conducting stock trades. Investors have flocked to invest online, with a prediction that computerized investing accounts will jump to 14.4 million by 2002, with assets managed online growing to $688 billion, according to Forrester Research of Cambridge Massachusetts. [1] These investors tend to exhibit independence, who seek cost savings, convenience, and control over their investment decisions. While online trading provides many benefits to traditional brokers (such as lower commissions and instant access to your accounts), it does encourage investors to make more undisciplined trading decisions. Concerns about scam artists "hyping" and "pumping and dumping" lower priced stocks in internet chat rooms and message boards have caused the Securities & Exchange Commission (SEC) to take action. Online brokers are expanding their services to include wireless trading, full banking services (checking, ATM cards, direct deposit, etc.), and international stock trading. This revolution caused by the Internet has been like no other on Wall St. and it is still in its early stages.
Who needs a broker?
The online trading revolution has eliminated the need for (or at least drastically reduced) the need for investors to place their stock trades through a professional broker who escapes with a high commission even if you lose money with his bad trading decision. Online brokers pose a serious threat to the full service brokerage firms and their cozy oligopoly. "The Internet is fundamentally changing the story of investing," says Gideon Sasson, head of Charles Schwab & Co.’s electronic brokerage unit. The online firms’ biggest advantage: radical cost savings. Online commissions have plummeted – down 50% in 1997 alone – as competition has mounted." [2] Now buying 200 shares of a $20 stock costs $8 at Ameritrade, $14.95 at E*Trade, $29.95 at Schwab, and an average of $116 at a full-service firm.
Currently, the full service firms are sticking to their full commissions, and do not even offer online trading yet (although several are the in the process of developing online services). The dean of do-it-yourself investing, Charles Schwab himself, says the big Wall Street firms are hopelessly behind the times. "It’s a lot like the guy with the buggy whip. Four wheels? What’s this thing called, an automobile?" mocks Schwab. He says the Internet poses a basic challenge to Wall Street’s consumer-unfriendly way of doing business: "I don’t think they’ve ever embraced anything that has empowered the individual investor." [2] Online brokerages should ultimately force full-service brokers to provide online services, reduce their commissions, and improve their brokerage service. While online brokerages should force these changes to come about, this does not mean that they will overtake the big boys. Credit Suisse First Boston Corp.’s online analyst Bill Burnham claims that "…the current online frenzy is narrowly dependent on "Internet users at Internet trading firms buying Internet stocks." [2] The bull market has played a big role in encouraging the online investing phenomena and there is speculation that once it is over, the real test will begin. One likely beneficiary of this war between online and full-service brokers will be the investor. Improved pricing, services, and products will result from their attempts to gain market share.
What to look for in an online broker
Online investing has significantly reduced the cost of commissions. The average commission that an online broker charges to make a trade is $15. Some firms will go as low as $7.95 (Suretrade), while others such as Charles Schwab which offer expanded services, charge $29.95 per trade. Most online brokers allow these commission rates on trades up to 5000 shares, but Ameritrade places no limits on how large an order may be. Web Street offers commission-free trades for Nasdaq orders of more than 1,000 shares on stocks valued at over $2. The online investor will obviously save more money with the lowest-priced commissions, especially as the frequency of trades goes up, but this in and of itself should not constitute the basis for choosing a broker. The broker’s reliability must be considered because the cheapest trading rates will not help you if their server gets jammed on busy trading days. For this reason, the online investor should consider choosing an online broker which offers comprehensive means of placing orders such as by telephone, proprietary software, and/or in person.
Real-time quotes are just like they sound – an instantaneous transmittal of a stock quote to the online investor through the online broker. Only a few online brokers offer free real-time quotes but more are doing so. Some charge an extra fee for the amenity to receive real-time quotes while others set limits on the number each customer can receive. The need for real-time quotes depends on the type of trading the investor wishes to partake in. Fast paced "day-trading" where one minute can make a considerable difference in the price of a volatile stock definitely requires the availability of real-time quotes. More traditional "buy-and-hold" strategies of trading stocks probably does not necessitate access to real-time quotes. At the very least, the majority of online brokers provide 15-minute delayed quotes for free.
Most online brokers provide research information, such as company reports, analyst recommendations, and historical data on price, volume, and dividends. Sites such as Schwab provide expert reports from Standard & Poor’s Corporation and First Call, but this is an example of the expanded services Schwab provides as a result of their higher commissions. The Internet makes it possible to obtain this research information that was once only available to the full service brokers – not the individual investor.
Online firms have expanded the amount of services that can be utilized via the Internet to much more than basic stocks. Initial-public-offerings (IPOs), mutual funds, American depository receipts (ADRs), high yield-bonds, Individual Retirement Accounts (IRAs) are now available from one online broker or the other. Some new products that online brokers are planning to make available to their customers will be the focus of a later section.
The technical support provided by online brokers should be one of the most important items considered when choosing a firm. If there is a problem with an account that prevents the investor from making that "hot" trade, they will want to be able to get in touch with their broker. All firms offer technical support via email but few guarantee a response during the same day. Telephone support is available but the customer may find themselves on hold for extensive amounts of time, especially during peak market hours, such as the opening and closing of trading. Some firms (Web Street and Fidelity) offer assistance seven days a week/ twenty-four hours a day, while others only offer help during the trading day (Datek and E*trade). After putting up with poor customer service response and missing out on a good trade because of it, the customer may be willing to spend more on commissions if they will be taken care of during a crisis situation.
What is the excitement all about?
The Internet and finance worlds meld perfectly together, due to the details that make up financial information and the Internet’s ability to constantly provide updated data. This explosion of readily available financial information and the ability to trade stocks directly has even created a new phenomenon: the day trader. The day trader will make many trades within one day, selling all of their stocks before the bell rings so that all of their holdings are in the form of cash. They believe it is too risky to hold a stock even overnight. Most day traders will hold onto their stocks for a matter of minutes. This type of investing, (if you can call it that) sounds more like gambling than investing.
As Forbes says: "Each day a 5 million-strong mob of online investors is proving that, when it comes to stock picking, might makes right. In their world, everything you have learned about rational pricing – earnings, book value, or even revenues – is meaningless. Don’t worry about the long haul. Trade for the moment. Make a killing. Hey, everyone else in the chat room [the cyberspace equivalent of the water cooler] seems to be doing so." [3] "I cannot wait to get up in the morning and trade. This is the most exciting thing in the world for me right now," a personal injury lawyer told Forbes. "My philosophy is to buy high and sell higher and not be afraid to take risks. I use no research tools or software; I just surf the message boards and look for volume." [3] While the Forbes article cites 5 million people, day traders only make up a small percentage of that number. The majority of online traders are buy-and-hold, but the number of day traders is increasing each day with the promise of making a quick buck. This event is similar to the gold rush out West during the 1840s.
A movement exists to regulate day trading. To take advantage of the fast pace of day trading, the name of the game becomes getting the word out about a certain stock. Internet chat rooms and message boards become billboards for all kinds of speculation. "Spamming" has infiltrated the Internet and people will post messages encouraging others to buy certain stocks even if no legitimate reasons exist to warrant the purchase. Often times, a person will buy a stock (usually a small-cap priced stock <$2) and post messages about it claiming that it is undervalued, or claim to know some upcoming information about the company that will skyrocket the stock’s value. Referred to as "pump-and-dump," this person will talk up the stock’s price and then sell the shares. The SEC holds the authority to stop scam artists from touting their stocks. In fact, the SEC has conducted two "sweeps" and charged 66 Internet spammers and chat-room operators with frauds, including touting – promoting stocks without disclosing that they had been paid to do so. [4]
139 members of the SEC Cyberforce sometimes lurk in investment chat rooms to be on the lookout for pump-and-dump schemes. [4] While the SEC has the authority to nail these scam artists, they do not have enough manpower to handle all of the complaints. They typically will receive hundreds of email complaints each day. The investors must make themselves aware of these scams. The SEC can not be everywhere at once. "At the end of the day, the public needs to wise up," says North American Securities Administrator’s Association Executive Director Philip A. Feigin, who likens trading on Internet chat-room tips to "buying stocks based on what’s written on the bathroom wall."
The Future of Online Brokers
As discussed earlier, online brokerage firms have expanded their services to go way beyond the offering of just plain stocks. These brokers have plans to continue expanding their services so that online investors will no longer need to keep their money in a traditional bank. Wireless trading will take place, with two-way pagers to provide trading access for mobile investors. The biggest change that may take place is the transformation of all the different exchanges around the world into one big round-the-clock exchange with trading occurring 24 hours a day/ 7 days a week. The new technological innovations offered by the Internet are radically changing the ways we trade stocks and manage our money.
Datek Online for example plans to offer checking account services, ATM cards, Debit cards, and direct deposit service. They currently offer a limited number of checking accounts to a pilot group and plan to make the service available to all of their customers in the near months. With all of these services available to the investor, they can have their paychecks directly deposited into their account which eliminates the need to mail a check or having funds transferred by wire to their investing account. In fact, all of these account will become one – investing, savings, and checking. Datek Online pays interest for all cash balances in their investment account – comparable to the rates of traditional banking institutions – and one could have easy access to this balance with their ATM or Debit card.
Wireless trading has been around in the form of cellular phones, but today’s advances in technology take the form of the palm-type electronic organizer with a wireless modem attached. You can trade while traveling, driving, eating out, playing golf, or even at your child’s school play. The devices may be programmed to vibrate when a stock reaches a certain price. This allows you to secretly trade during a business meeting for example while it looks like you are taking notes. Discover Brokerage plans to offer a wireless service in the coming months, but most of the other online brokers have not announced any definitive dates. Currently these services cost a considerable amount ($360 to buy the pager and $50/month from Fidelity), but in a few years they should be both commonplace and affordable. [5]
One of the services currently allowed on the Nasdaq is after-hours trading. This trading allows certain people (namely a select group of institutional full-service brokerage firms) to trade shares after the market is closed to most traders. There is growing speculation that the Nasdaq will extend its trading hours into the evening so that people that work during the day would have the opportunity to trade stocks. In fact, the Nasdaq will shortly be voting on whether or not to extend the trading hours starting as early as May 1999. Ameritrade has announced plans to offer international stock trading, that is the ability to trade stocks on foreign stock exchanges with an online account. A movement to create a single pan-European exchange is gaining momentum following the London-Frankfurt alliance last July. [6] Once Europe begins to trade on one exchange, it will only take one other major player to announce a link to start a chain reaction. The network of old-fashioned exchanges will be beaten out by the Internet. Some say that eventually investors will be trading 24 hours a day, every day of the year on one globalized exchange.
Started about five years ago, online investing has caused a dramatic shift in how the securities business is being conducted. Millions of people let their fingers do their investing, lured by the speed, convenience, and low commissions. A steady stream of new technology continues to become available to investors. The Internet has truly revolutionized the ways in which we will trade stocks in the new millenium.
Works Cited