By consolidating information, optimizing tools, and continually ramping up speed and flexibility, online trading has become big business within little more than a decade. Investment giants have lumbered into the fray along with software startups, and today every online trading platform aims for the edge that will make it—at least for an online minute—the one to beat.
The earliest sign of change in the hallowed halls of trade was in 1969, when Instinet removed the broker from the transaction and allowed institutions to trade directly with each other. When Bill Lupien took over Instinet in the early 1980s, he realized that an electronic system could give a substantial edge to brokers and limited its distribution to professional traders. In 1987, Lupien sold to Reuters Group PLC.
After a 1994 study by William Christie and Paul Schultz revealed data irregularities among NASDAQ stock prices, the Justice Department investigated price-spread practices. Electronic communications networks were the trading platform of choice for market makers, and the Securities and Exchange Commission implemented rule changes requiring that ECN prices be listed on NASDAQ.
This access to pricing, new order-handling rules, and the growth of the Internet slowly inspired an audience of retail investors and day traders; growing traffic and volume meant richer data, greater pricing accuracy, and more liquidity.
While Instinet continued to be available only to market makers and specialists, Island and Posit were ECN marketplaces that emerged in the mid-1990s to display and match buy-sell orders between brokers, institutional firms, and market makers. Before the end of the decade, the number of players had grown.
Then came the birth of K. Aufhauser & Co. Inc., later incorporated into TD Ameritrade (NASDAQ: AMTD); Charles Schwab (NASDAQ: SCHW); Scottsdale Securities, later Scottrade; and Investools’ thinkorswim (NASDAQ: SWIM). “We started when the Internet was already humming,” says Tom Preston, thinkorswim’s founding partner. “We didn’t have pre-conceived ideas about how people would trade.”
By 2000, the SEC reported that the Internet was being used as an investment tool by 15 million American stockholders, but less than a third of them were trading online. Most were checking the status of their investments and doing research. Of those who were trading online, delayed trades, poor broker communications, security concerns, and technical difficulties were common complaints.
Still, the benefits of electronic networking offered new possibilities for full-service and discount brokerage firms, both conventional and online. The marketplace is driven by profit. In the Internet business model, many of the payers are advertisers. Capturing pay-to-play traders (or read/click ad traffic) has meant striking a balance between reliable products, quality service, “human touch,” information, novelty, education, and technical efficiency.
The heated competition for price advantage with low minimums and low per-trade fees continues today. The cost of customer service—from licensed brokers to technology help-desk workers—bites into profits. While some Internet investment sites continue to offer high-touch person-to-person broker contact, most are replacing the one-on-one broker-investor model with an ever-widening array of self-guided investment and support services.
Commission structure is another point for competition, with many sites using low fees to attract new customers. TD Ameritrade offers a flat-rate commission no matter how many shares are traded, and E*Trade (NASDAQ: ETFC) charges less than $13 for market orders based on the number of trades per quarter. Though it operates with higher commission fees, Fidelity Investments charges no handling or maintenance fees, and optionsXpress (NASDAQ: OXPS) doesn’t require a minimum deposit to open a cash account. Schwab Corp. recently simplified its commission structure, divesting of its bottom-tier commissions to better compete.
MG Financial’s recently released DealStationFX draws traders looking for faster execution, flexibility, and streamlined order management. “DealStationFX is a complete package designed to help our clients achieve their goals in the fast-moving forex market,” says Marla Miller, chief operating officer at MG Financial Group. “Transparent order execution at fixed spreads combined with limitless possibilities for customization and integration are just a few of the many features offered by the new platform.” DealStationFX is available in several languages and lets traders manage orders directly from charts, rapidly place orders by using the “One-Click” option, and enhance their technical analysis by integrating key fundamental figures and Dow Jones news into the charts.
Growing customer sophistication and demand has led many trading sites to offer options, futures, ETFs, CDs, foreign securities, fixed income, and other products. Zecco Holdings offers 10 free stock trades per month and options trades for less than $5. Interactive Brokers Group (NASDAQ: IBKR) offers a “universal account” with which users can trade several different products on U.S. and foreign exchanges. As audiences broaden and the concept of online investment is tested by latecomers, investment sites may also offer no-fee, tax-advantaged retirement and education accounts, free checking, ATM access, automatic bill paying, and credit cards with low interest rates.
“Online trading is moving toward empowering consumers through a combined offering of online and offline education and advanced tools,” says Kevin Dodson, Scottrade’s director of online financial services. “By offering customers these advanced tools and educational opportunities, we are helping consumers make better informed investment decisions.”
Today’s sites are subjected to constant grading by Barron’s, Consumer Reports, Kiplinger, and other paper and online publications, as well as blogs and consolidated reviews such as ConsumerSearch.com. Such reviews combine objective and subjective measures using audience appeal, trade and traffic volume, and awards.
Whatever their edge in the marketplace, online investment sites are continually challenged to improve the customer experience. “When I moved from professional trader to retail trader, I tried to use existing platforms, and it was just painful,” Preston says. “It was difficult enough just to buy a stock, but it was even harder to do a spread order, and I lived and died by spreads. So we said, let’s build a system that we would actually want to use.”
“In last few months, Scottrade has launched the Scottrade Online Community and was the first brokerage firm to offer NASDAQ Velocity and Forces,” says Dodson. “These tools are part of Scottrade’s continued commitment to educating our customers and providing easy-to-use-tools to help them be more successful with their trading strategies and improve their all-around Scottrade experience.”
“More and more, we’re seeing that [companies] operating on top of the Internet are also providing the infrastructure and platform upon which business will be done,” says Lynda Applegate, a professor at Harvard Business School. “The ability to play above and below the line is fundamental to success because it provides revenue streams.”
The key is to identify and “profile” customers and their needs. Each online service has a niche. According to Richard Levine, vice president of Charles Schwab Active Trading Services, Schwab’s active investors tend to be affluent. “A large percentage are over 55,” he says, “and they’re generally more educated than the average active investor. Many have been trading for over 10 years—it’s a very discerning and sophisticated client base.”
Of the thinkorswim crowd, Preston says, “Our customers trade upward of 170 times a year. Anecdotally, I’d say our average customer is between 45 and 55, and as likely to be a woman as a man. They have a margin and an IRA account. They tend to be very comfortable with technology, but they like to be able to pick up the phone to talk with someone if they have a problem or a question.”
Once an audience is targeted, “the problem is getting people involved and getting them to participate,” says Jeff Kohler, a long-time trader who runs optionaddict.net. The current buzz—pioneered successfully on non-trading sites such as MySpace.com and Facebook.com—is social networking. Allowing traders to share information, sources, experiences, and opinions has become a requisite element of trading sites. “Even if they swing and they miss, everyone’s doing it together,” Kohler says.
“Active traders are very social individuals, always looking to gain an edge,” Levine says. “They love to learn, test their strategies, and get input from other traders. We recently introduced the Schwab Active Trading Online Community, which allows them to create and participate in discussions and polls, create and read user-generated blogs, post personal profiles, including photos and videos, and ‘private message’ individuals within the community.”
Kohler says that experienced online traders are also looking for flexibility. “They’re trading on PDAs, their mobile phones,” he says. “They’re setting up their computers so they can walk away and place trades while they go to lunch.”
“They don’t want to be tied down,” Preston says. Thinkorswim offers four mobile applications: thinkPod for iPhone and linked community, thinkMobile for mini-browsers, thinkAnywhere for Pocket PC devices, and thinkMicro for BlackBerry and Nokia phones.
Keeping up with the changes is demanding. “We have a very aggressive software release schedule,” Preston says. “Each month for the past eight years, we’ve given customers five or six new features or product enhancements. And 70% of what’s built is from customers’ ideas.”
To keep up with evolving customer expectations, online services will need to maintain service despite a heaving market and cater to the fast-growing, self-directed investment community. With many online brokers adding investment advice, portfolio analysis, and financial planning services to their platforms, today’s active traders can rely more on online trading sites and less on visits to brokers.
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