By THERESA W. CAREY
Move over, propeller-heads. Trading stocks on the Internet is no longer the sole province of the computer cognoscenti. And that marks quite a change from our first two years of doing this survey, when the ranks of online traders seemed to be dominated by gadget freaks, early adopters and bargain hunters. This time around, it seems that those folks have been joined by hordes of mainstream investors.
Last year, in fact, online customers accounted for an estimated 17% of all retail stock trades, more than double the previous year's level. This surge in volume was helped along by improved quality at almost all brokers' World Wide Web sites, not to mention sharply lower commissions.
Reacting to investors' wild enthusiasm for online trading, dozens of brokers have gotten into the game. Right now there are more than 50 brokerage houses offering online trading, up from a mere 12 when we first did our survey in 1995. And they aren't standing still. Virtually every one of the sites we ranked a year ago underwent significant upgrading during 1997.
Clearly, one of the attractions of online trading is the vast amount of free financial information that can be had online. While the Internet may have fallen short on a lot of its promise, that isn't the case in this area. The simple fact is that any investor with a modicum of market savvy can mine all the data needed to make trading decisions -- and execute the trades. The challenge to full-service brokerage houses, of course, is that all this can be done without the services of a high-priced customer's man.
Indeed, the plunge in online commissions has been enough to shake up some of the discount brokers, let alone the full-service shops. By the fourth quarter of 1997, the average commission charged by the top 10 online firms was slashed by more than half, to $15.95, down from $34.65 a year earlier, according to Bill Burnham, an analyst with Piper Jaffray.
Today there are an estimated three million online-trading accounts, according to Forrester Research (www.forrester.com), and that number is expected to grow to 14.4 million by 2002. Forrester's figure would be even higher if so many people weren't abandoning proprietary, dial-up trading systems. These old packages are being supplanted by firms that allow customers to trade on the Internet. One of the important advantages of the 'Net is that it doesn't require installing a separate program on a customer's computer. That's not to say that stand-alone packages will disappear altogether; Forrester estimates that about a quarter of online traders still are using proprietary programs. But the firm projects that stand-alone software usage will dwindle to less than 3% of online investing accounts by the turn of the century.
The initial push into online trading was led by discount brokers who simply gave existing clients electronic access to their funds. Then along came upstarts like E*Trade and Lombard (now Discover Brokerage), and they stole customers from the traditional discount brokerages. Discount giant Charles Schwab still dominates. Piper Jaffray estimates that of the 153,000 daily trades executed online during the fourth quarter of 1997, 30% went through Schwab, with E*Trade picking up 14%. Waterhouse Securities and Datek tie for third place with 8% of the market, with Fidelity, DLJDirect, Quick & Reilly, Ameritrade and Discover queuing up right behind them. Julio Gomez of Gomez Advisors noted in an interview with PC World Radio that an "establishment" is now emerging in online investing, thanks to the huge investments made by DLJDirect (formerly PCFN), Schwab and E*Trade, in addition to the long-awaited debut of online trading for Merrill Lynch account holders. Last year's bumper crop of online brokerages will, most likely, shrink by year-end, opines Burnham of Piper Jaffray. Burnham expects consolidations in the latter half of the year, once growth in trading volume levels off and brokers realize what it's costing them to attract new customers.
What seems likely to happen as the industry matures is an increasing effort by various brokers trying to target different segments of the online trading market. Craig Prickett, Schwab's director of electronic brokerage marketing, observes, "The early adopters were the more active traders, but now we're approaching this area where our online customer looks like our average offline customer. Schwab customers aren't as price-sensitive as the customers of the deep-discount brokers." Other firms, meanwhile, are likely to target the active traders who tend to look for rock-bottom commissions. Barron's readers want it all, of course. Price is an important criterion, but only one. Our top four brokers this year -- Discover, Web Street Securities, Datek and DLJDirect -- offer enviable combinations of service and price. Discover, once again ahead of the pack in our rankings, has just undergone the latest upgrade of its site. If you can overlook the color scheme -- shades of Discover pumpkin combined with Lombard teal -- you'll find a site that's packed with data and up-to-the-minute information about your account.
The next tier of brokers offers a different set of strengths: Day traders will prefer Datek and Web Street Securities, while traders looking for one-stop shopping and plenty of opportunity to talk to a live broker will prefer DLJDirect and Waterhouse.
What stands out most in this year's review is huge leaps forward in quality, for the entire group. Every site has more research available, and more online help as well, and our rankings reflect this. In 1997's survey, several of the brokerages reviewed inspired cringes of apprehension; this year, only one of the brokers in the pack looks like it's not worth the commissions being charged. That's not to say that online nirvana has been attained. Remember that during last October's high-volume market crash, customers complained loudly about an inability to execute trades or to get touch-tone alternatives. But the online brokers say they've learned from that experience and will do better next time.
In this roundup, we're focusing solely on Internet brokers, and have examined 19 offerings in depth. We narrowed our focus to include Web-based brokers who are in the Piper Jaffray top 10 in terms of market share, as well as those who rate highly on Julio Gomez's Internet Broker Performance Monitor (www.scorecard.com). We also required brokerages to provide us with a way to test the actual execution of trades.
We ranked the brokers in five key areas on a scale of 1 to 5, with 5 being the highest.
This year we included a trade execution category, in large part because our readers wanted to know what they were likely to experience in this area with any given brokerage. As it turns out, some of the sites have surprisingly clumsy trading screens, initially complicated by the number of mouse clicks it takes to get there in the first place. Some brokers make you get a quote from another place on the site, then remember the prices you saw, return to the trading screen and fill in a bunch of boxes. Then you have to click on a button that takes you to a confirmation screen, which may or may not provide an updated quote. Finally, after verifying that you punched in the right information, you can go ahead and enter the order into the broker's system. After you're done with data entry, you have to figure out whether your order was executed, and at what price. Some brokers do not make this information readily accessible. After experiencing this version of computer hell, you sometimes have to wait a day to find out your account status and to get portfolio reports to reflect your trade.
During our testing, we realized the perfect site does not exist. Some come close, but so far none has reached our trader's Valhalla, which would minimize the number of verification screens by checking data field-by-field as it's entered, while maximizing the amount of data available at the time of the trade.
A real-time quote, presented before the order is entered, is essential. Also, drop-down list boxes that eliminate the need to do a lot of typing are very helpful. For example, if the trader selects "Sell," there should be a drop-down box that contains the ticker symbols of issues available, thus avoiding data-entry errors and inadvertent short sales. An easy-to-read verification screen that does more than just echo back the data entered is necessary. Finally, an instant link to the status of the order, followed by real-time updating of the trader's portfolio, is also vital.
We did not take a stopwatch and time the execution of market orders, mainly because we'd need quite a few more computers and phone lines than we had available during the testing. We executed equity trades on all 19 of the ranked brokers during market hours, performing a market buy and a limit sell of a Nasdaq stock. Following the market buy, we evaluated the execution and portfolio reports. After the limit sell, we examined the open order reports and looked at ways the trader follows the progress of the order. A "5" in this category means the order entry and execution process flowed easily from one step to the next, with real-time information available when needed. Perhaps unfortunately, we also couldn't arrange for a manic market meltdown such as the one last October 27 to test the sites under battle conditions.
Ease of use: How easy was it to navigate around the site? Does the layout of the site make sense and minimize the number of mouse clicks it can take to get from one place to another? A "5" in this category means the site was well designed and simple to use.
Reliability and range of offerings: Was the site accessible every time we loaded it? Did the graphics snap onto the screen, or did they crawl? We looked at two industry surveys, Gomez Advisors' first-quarter Broker Performance Monitor scores as well as Don Johnson's Discount Brokers Ranked from January, to help determine reliability. The range of offerings was more important the past two years; almost all of the sites ranked offer equities, mutual funds, options and fixed-income securities now. A "5" in this category means the site is reliably accessible at reasonable speeds, offers a wide range of tradable investments, and lets you reach a live broker or make a trade via touch-tone telephone, if desired. Research and other services: Can you get quotes, charts, news and analysis? Is it easy to see how your holdings or other issues you're watching are performing? A "5" in this category means a broker has a wide variety of proprietary information, along with real-time quotes, available free for trading customers, or has links to data from other providers at no additional cost.
Commissions: What's the bottom line? A "5" here indicates a commission of under $10. A "4" is awarded for trades of $10-$15, "3" for commissions ranging from $15 to $20, "2" if the charges are $20-$30, and "1" if the commission is over $30 for an equity transaction. We narrowed these ranges this year to reflect the overall falling prices in the online trading world.
While we expect to see continued improvement in features, notably order-entry screens with real-time portfolio updates, we also anticipate shrinkage in the numbers of Internet brokers out there. Consolidations and shakeouts seem all but certain in this crowded marketplace. Joe Fox at Web Street is openly in the takeover market, and says his company plans to expand by acquiring other brokerages this year. But as with everything to do with the 'Net, the hype can exceed the reality. Anthony Huston, executive vice president of marketing and new media at A.B. Watley, avers that Web technology may not yet be ready for prime time. "It's ready for the investor who wants to make a trade every few days or so, but it's not for the truly active trader," Huston says.
And commissions? They've dropped like a rock in a cold stream this year, but may be near the bottom. As Schwab's Prickett notes, "If price alone was the main factor, Motel 6 would be the top hotel chain in the country." Frequent traders are driven to find a way to minimize commissions. But for the average active trader, who may have a few transactions a month, commissions have fallen so much already that they may not be nearly as important as other factors. The difference between a $19.95 and a $9.95 charge hardly registers on a trade of 100 shares of Intel, worth $7,500. And either is vastly lower than the $100 or so a full-service broker might charge, or the $75 charged by a traditional discount broker.
Perhaps the safest prediction is for more of the same. In the intense battle for customers, online brokers will continue to provide more features and services without charging more and, if it's possible, maybe charging even less. And the only sure winner in this will be the object of all this competition -- you, the online investor.
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