The Risky Business of Online Stock Trading

Online securities trading was a big fad a few years ago, but some of the major players disappeared from the scene after the dot-com fallout. However, many do-it-from-home traders cannot resist the Internet’s speed and convenience, and there are still plenty of firms to accommodate them.

Although some major brokerage companies swore they would never offer access to electronic trading tools, many quickly learned that customers were eager to trade via the Internet, and realized they would need to provide services or lose them to the competition.

Currently, online trading is gaining credibility.

Electronic storefronts offer consumers dedicated Web sites, software and online trading tools to help them go it alone. Some online investing firms have begun offering limited to full professional investment consulting services for a fee.

“Online trading is more than a passing fad. Many individual investors are using online brokers today,” Fred Ruffy, an analyst at Optionetics, told TechNewsWorld.

The cost of trading online is generally lower than at brick-and-mortar brokerage houses. In addition, improvements in technology and security have made online trading an efficient and safe experience. In fact, some online brokers, such asE-Trade andTD Ameritrade, offer more than just trading. They also provide credit cards, mortgages, bonds and mutual funds, for example.

Stiff Competition

Online trading has rendered phone brokers obsolete. Before the dot-com bubble burst, a phone trader working late at night at a big-name brokerage firm would field roughly 300 calls per shift.

When online trading began to gain popularity, many phone traders were laid off, due in part to a decline in sales volume. The interest in online trading is even more intense now.

“We see a burst of activity. It’s going up and down, but always there are those investors who want to do it themselves,” said Andy Rolfe, CTO ofAuthentify.

The number of online traders has been increasing, apparently in spite of scams — or the fear of scams. “People believe in the institutions that exist online,” said Rolfe.

Falling Rates

Falling revenue from commissions has been the challenge for many online brokers, according to Ruffy. In October 2006, for example, many online brokers lost share value after Bank of America announced that it would offer free stock trades to select customers.

“This is part of a trend. Many of the big players try to get customers by offering cheap stock trades and then selling them other products or services,” Ruffy noted.

Consolidation is another reality for the survivors of the dot-com boom, he said. Many small players have been forced to partner with others in order to avoid going out of business. Those intent on resisting the merger trend must carve out a niche in order to succeed.

“The outlook is for more of the same. However, there are fewer and fewer brokers out there. The main players in online trading will probably remain the same,” Ruffy predicted.

Lay of the Land

The online trading industry is now comprised of two groups: online discount brokers and trading software platform providers. Companies in both categories provide low-cost commissions and fees for stock trades and other investment activity, said Kenneth Prather, owner ofPrather Investment Management.

Online discount trading commissions range from US$4.95 to $14.95 per trade, noted Prather. By comparison, full-service brokerage firms may combine counseling and trading fees; customers can pay as much as $100 in fees and commissions per trade, he pointed out.

Online discount brokers cater to investors who are looking for low-cost brokerage services. They are very active online traders who remain loyal to a particular broker’s site, according to Prather.

The leading players in this field areFidelity,Schwab, E-Trade and Ameritrade.

The second group is comprised of online trading companies that rely on providers of trading software or a specific platform. These companies also offer brokerage services for additional fees. Some of the well-known players in this category areeSignal,MetaStock andTradeStation.

“These trading companies offer pretty low commission rates, usually offering trades for pennies per share. Traders can get any stock on the market,” Prather said. “It is a full range service industry, including equity, futures and options. It is a very open business.”

Security Concerns

From a security standpoint, online traders may face considerable risk, but the investment industry has started responding to security issues — in part, because of federal compliance regulations.

“Growing security concerns stem from the use of passwords as the sole form of identification online,” said Rolf. “Federal regulators are starting to insist on multi-factor identification.”

As a result, online trading is becoming safer. However, as e-commerce in general becomes more lucrative, the number of identity thefts and threat attempts is growing. This is driven by the increasing number of users who do business online, as well as the sophistication of hackers, noted Rolf.

“We have always known that hackers had an automatic repeat and remove vehicle to steal users’ IDs,” he added. “That is where the problem lies: using phony accounts to push up or down the price of stock.”

Avoiding Pitfalls

Aside from the security concerns that impact all aspects of e-commerce, there are other threats unique to do-it-yourself online trading. If the investor does not already use a system, it is only a matter of time before he loses his money, Prather warned.

The bottom line is that online traders can become too aggressive, and it can be very easy to lose one’s shirt. It is not uncommon for avid traders to roll over their 401k funds or other investments — only to lose everything in the stock market.

“Online trading is a double-edged sword. Users get more access and more trading tools. That is the advantage,” Prather said. “The downside is when users think they can become a real stock trader at home working towards getting rich. Online trading can be very seductive.”

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