Online Trading: More Power to the Investor - Industry Trend or Event

Direct-access trading firms are finally delivering what online brokers have long promised: Giving investors independent control over their trades.

TODD MARCUS' GRIPES ABOUT stock brokerages are familiar enough: They offer too little control, insist on a middleman who makes money from stock trades and take what seems an eternity to confirm a trade.

The brokerages Marcus dislikes aren't the stodgy Wall Street variety, but the online brokerages like E-Trade and Ameritrade that have reshaped the world of stock trading. So Marcus, who makes multiple trades a day, turned from these to Edgetrade.com, one of the new breed of direct-access firms that use Internet technology to do the innovations of online brokerages one better.

"Now, at the touch of a button, before you can even take your finger off the button, you can own a stock' says Marcus, who boasts that direct access saves him at least 6 cents a share on every trade.

Better, faster, cheaper. The mantra is a distinctly American one, and it's perhaps never more relevant than when the subject is money. While many investors, content with only a few trades each year, are not yet clamoring for faster and cheaper stock trading, active traders are hungry for technology that helps them move quickly.

"We're an impatient society," says Russell Keene, VP of equity research at Keefe, Bruyette & Woods, an investment research firm specializing in banking and financial services. "Tell me if I got it, and I'll be on my merry way."

Direct-access trading firms would like to help the average investor "get it. Where Internet brokerages failed to fully eliminate the middleman (some, like E-Trade, are building a team of financial advisers), directaccess firms offer software that lets all the buyers and sellers of a particular stock deal directly with each other. No salesman is involved -- not even a broker to execute the trade.

If the stock market is a battlefield -- which it has resembled recently -- direct-access firms view their software as a weapon of war. The tools help an investor scan the entire market for the best available price before buying or selling a stock.

"The technology gives the ability to have the order reflected directly in the marketplace, without stopping at the middleman's desk, where they can control the order from that point forward," says Joe Wald, CEO of New York-based Edgetrade. "Without that middleman trying to make money on your order, you're in control of the execution."

That control can save investors money. Say, for example, you want to buy 100 shares of Cisco. The offer price ranges between $66.130 and $66.25. A market order will likely be filled at the higher price, allowing the broker more of a profit. A limit order -- which picks a specific price at which to buy or sell -- will usually go through only if the brokerage can make money or break even.

Direct-access technology, meanwhile, lets you enter your own bid --$66.188, for example, which effectively cuts the spread in half and lowers the cost of the transaction. The potential savings are greatest for heavily traded stocks; high volume simply means many more bids and offers for the investor to select from.

Filling an order may be the job of brokers, but finding the best price for the investor isn't their first priority, say proponents of direct access. When the investor determines the price, the savings can be significant. On an order of 1,000 shares, a difference of $0.0625 represents $62.50 in savings. Every $0.125 equals $125. These are the hidden cost of trades executed through a traditional broker; as trading activity increases, so, too, does the savings. "Everyone knows about the commission, but the commission is not the sole cost of the trade," says Wald. "The commission is a sham. They're making money off the order flow."

Direct-access firms cater primarily to the active trader, making from 10 to 400 trades a year. For those traders, fractions of a point represent larger gains or steeper losses. But the firms say they're aiming to democratize the process, hoping to bring average investors into the fold.

This won't be easy. The software is technical and is bound to overwhelm investors at first. But active traders represent the fastest-growing segment of this market. By using the Internet to offer more market information than ever, the firms aim to empower consumers like never before. Industry observers say this can only be a good thing. "Investors ultimately should have the opportunity to make a split-second decision," says Keene.

All this empowerment comes at a price, though -- one that might initially scare away customers. Edgetrade charges a commission of 2 cents a share, in addition to $180 per month to license its software. Cybercorp's licensing fee runs $99 per month, and per-trade charges vary from $9.95 to $14.95. Direct-access execs say the fees are recouped in the savings yielded from trading, but they still may have a hard time attracting customers who are accustomed to flat fees of $10 or less per trade.

Another hurdle is the market conditions. In a volatile, uncertain market, some investors may be happy to turn the reins over to a more experienced hand. While investors typically want to buy and sell stocks at a desired price, in a stagnant or down market many are more concerned with simply staying afloat, and may want a professional life raft -- a broker -- to help.

The firms say such a possibility doesn't worry them -- and to be sure, they have reason to be confident. The direct-access niche may be young and small, but its growth has so far been robust.

Cybercorp, among the leaders in the field, has a mere 6,500 customers -- but that's triple the number it had nine months ago. Cybercorp revenues grew 400 percent last year, and the company saw more growth in the second quarter this year than in the first, in spite of a tumbling market. Edgetrade, a much smaller firm, started from scratch four years ago and today has 400 clients.

The real vote of confidence for the burgeoning industry came earlier this year, when Cybercorp was bought by standard-bearer Charles Schwab. Industry executives think the $500 million purchase was an acknowledgement of the threat posed by direct-access firms, and a clear statement that the industry is here to stay.

The growing presence of direct-access has at least a few well-known brokerages on the defensive. The active traders, who are the online brokers' most beloved customers, will soon demand these capabilities, if they haven't already. "Online brokers that ignore it are going to slowly lose their client base," says Keene.

No one expects direct-access firms to make a big impact in the short run. It will be a niche business for a while, thanks to its highly technical nature. "In order to take direct-access brokerages to the next level, we must make the software easier to understand," says Philip Berber, chairman of Cybercorp.

Still, as the popularity of stock ownership grows, so will investor demands, analysts say. And while the biggest direct-access firms compete, they also profess to fight a common enemy: Wall Street and the traditional function of the brokerage firm. The difference in traditional and online brokerages was obvious -- online trading eliminated the phone, and with it the broker's voice. But direct-access takes it to a higher level, sending the small investor into the market's fray.

"Millions of investors are frustrated with the slowness of execution and are curious about the prices at which they're getting filled," says Berber. "That's what's driving this."

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