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TRADE
SECRETS
WHAT WALL ST. DOESN'T WANT YOU TO KNOW
by Jason Zasky
Listen to the proselytizing of online brokerages and you hear that
Web trading is the fastest, least expensive option available to the
public. Not surprisingly, cost-conscious consumers are flocking to
brokerages such as E*Trade, Datek Online and Ameritrade, attracted
by inexpensive commissions and the sense of empowerment that comes
from trading via the Internet. Yet, the fastest and most efficient
method of stock trading is hidden below the average investor's radar
screen, in part because it's an option that Wall Street doesn't want
you, the investor, to know about. Called direct access trading, this
alternate method allows individuals to buy stocks without the cost
and delay necessitated by a middleman.
Although direct access technology has been available for a decade,
the financial industry has had little incentive to promote its existence.
Brokers and 'market makers' (the middleman) are making enormous profits
off the already established system. In a nutshell, market makers pay
brokers for orders ("payment for order flow") and market makers pocket
whatever spread (the difference between the "bid" and "ask" price)
is available in the market when fulfilling a client's order. In a
traditional trade, for example, if you wanted to buy 1000 shares of
stock X and it was selling for $50 a share, the middleman might require
you to pay $50.125 per share to purchase the stock, pocketing the
extra $125 for himself.
"They took $15 from your left pocket and $40 from your right, but
you only knew about the left."
"Direct access allows customers to use the same systems, tools and
information that the hidden middlemen are using and keep whatever
spread or savings they can make on that execution themselves," says
Joe Wald, CEO of New York-based EDGETRADE.com. For that service direct
access firms generally charge pennies a share. "People are being lured
[to online brokerages] by $15 commissions," continues Wald. "What
about the $40 you lost on the execution? They took $15 from your left
pocket and $40 from your right, but you only knew about the left."
Until recently, direct access was used almost exclusively by professional
investors, mainly because the tools are quite sophisticated and require
extensive training, making them impractical for the casual trader.
However, companies like Tradescape.com and TradeCast are beginning
to cater to the investor that trades just a few times a week. As firms
like these move down-market, online brokerages will come under increasing
pressure to provide similar services.
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Meanwhile, the
well-documented customer service struggles of Web brokerages continue.
"The indirect model is full of flaws—it's a customer service
nightmare," says Wald. "Most complaints about online brokers are from
customers not being able to cancel an order or get back a confirmation
as fast as they thought. Or there was a difference between the price
that got executed and the price on their screen."
Todd Marcus, a client of EDGETRADE.com for the past year-and-a-half
concurs; "With online brokers you feel like you're not in control,"
he says. "You put your order in, you don't see how it's getting executed
or where it's getting executed. You never know if you could have bought
the stock at a cheaper price."
The ability to manipulate direct access technology doesn't happen
automatically. A trader interested in using what is referred to as
Level II systems (online brokerage customers only see Level I) must
invest the time to learn the software and the strategies to implement
it. The best direct access firms offer intensive instruction to prepare
new customers.
"A lot of people believe they can log-in and by some genius be able
to compete with everybody on Wall St.," says Wald. This may account
for why so many so-called day traders wash out so quickly. Beyond
training, what distinguishes direct access traders is psychology—how
individuals react to real world situations. "We might be looking at
the same screen," offers Wald, "but if we enter the same position
at the same time you and I are going to behave differently." How well
a person handles the outcome of trades also plays a role. "Even the
best traders frequently make mistakes," notes Wald. "It's the degree
and how you are reacting to those mistakes. Theoretically you could
lose on nine of 10 trades and still make money."
Whether or not direct access will become the predominant method of
trading remains to be seen, but eliminating the role and subsequent
cost of the middleman is a powerful lure. As direct access technology
becomes more accessible to the average trader there is likely to be
a paradigm shift in how Wall Street does business, resulting in more
money and control for the individual investor.
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