BUSINESSWEEK ONLINE : MAY 22, 2000 ISSUE
COVER STORY Commentary: Trading Online: It's a Jungle Out There How to make sure your trades are getting the best execution Are stock markets safe for online investors? If you trade on your own via the Internet, you've already accepted the risk that you might pick losers or walk headfirst into a market correction. But today's high-speed, high-volume markets pose new risks that most investors aren't even vaguely aware of. Consider: If you trade with an online broker, your order for a Nasdaq stock doesn't automatically go to the dealer who's most eager to sell. Because online brokers sell cheap, automated trades, your order is almost certain to be routed to a ''wholesale'' market maker that pays your broker to send orders its way. The market maker will match, but not necessarily beat, the market's prevailing price. One of these mega-market makers may control 30% or more of the orders for a stock, reaping info the dealer can use in trading for its own account. Place an overnight order to buy or sell at the market opening, and you give the dealers a clear signal to push prices up or down against you. Regulators are beginning to focus on these problems. At the Securities & Exchange Commission, ''our job is to make sure that investors don't have to be market-structure experts to get the best price possible,'' says Robert Colby, deputy director for market regulation. The SEC is considering regulations that would force market makers and brokers to spell out their record on executing trades and may stiffen order-handling rules to give individuals more breaks. But until regulators catch up, you've got to know enough to make sure you're getting the trade execution you deserve. Even limit orders, recommended by SEC Chairman Arthur Levitt Jr. as the individual investor's best tool, don't always work. A limit order specifies that you'll buy or sell shares at a price you pick. If your limit price beats the order offered by the dealer who gets your order, the dealer has to post your order where it will have a chance to be filled. But an SEC report on May 4 found ''serious neglect'' of these rules, including three mid-tier Nasdaq market makers that mishandled 46% to 92% of the orders examined. Thousands of customers lost the chance to buy or sell stock at favorable prices. What's at stake? In the worst case, an unfilled limit order can cost you hundreds of dollars if you can't buy before a stock takes off or sell before it plunges. Poor execution usually means you pay a sixteenth or an eighth of a point--6.25 cents to 12.5 cents a share--more than you might have. On a 500-share order, that's $31.25 to $62.50--in a market where investors switch brokers to save $5 in commissions. ''Everybody's happy with $9.95 trades, but they're not looking at what their broker really costs them,'' says Bill Burnham, a venture capitalist at Softbank Capital Partners in San Francisco. Poor executions, Burnham and other critics say, stem from the consolidation spurred by the huge volume of online trades: Out of 457 active market makers in March, the five top wholesalers controlled 32.5% of Nasdaq's volume. The biggest, Knight/Trimark Group, handled more than 20% of the volume in 120 of Nasdaq's 1,000 most active stocks. With that much information about supply and demand, a firm has a powerful edge in trading for its own account. That knowledge is most useful in the ''pre-opening''--the hour before Nasdaq starts trading retail orders at 9:30 a.m. (ET). Armed with overnight orders, big market makers post bids on Nasdaq to push prices up or down. Adjusting prices is part of making markets--but Frank Hatheway, a Penn State finance professor, says that the big wholesalers frequently overdo it. The result: Customers who buy at the opening pay more, and sellers collect less, than later in the day. Regulators are trying to fix this shadow-trading: In June, Nasdaq will start requiring dealers to put real money behind pre-opening prices. Even wholesalers concede that pre-opening maneuvers need to be cleaned up. But they insist they don't use their information advantage during trading hours against their customers. For parent Charles Schwab and 300 other brokers, wholesaler Schwab Capital Markets says it automatically fills orders of up to 3,000 shares at the market's best price. On Apr. 14, when Nasdaq fell 355 points, ''we had hundreds of millions of our capital at risk, because we left the auto-execution on,'' says Lon Gorman, CEO of Schwab Capital. And brokers watch constantly, he says, to ensure that Schwab gives them the best executions possible. That might not be enough. You've got to monitor your own trades, too. Fortunately, it's getting easier. Some brokers, like Datek Online Brokerage Services, are rolling out streaming quotes that adjust as trades go off. What if you spot a bad trade? Contact your broker's customer service department--and be sure to mention the firm's ''best execution duty,'' an SEC phrase that might help get some attention. Follow up in writing. Online brokers aren't known for their responsiveness, so you might have to be prepared to switch. If you do switch, look for a broker that makes heavy use of ECNs (electronic communications networks). These Nasdaq substitutes match buyers and sellers automatically at a single price, without the dealer spread. But an ECN doesn't guarantee your order will be filled. Only one, Island ECN, has enough trading action to boost your odds. Another, Archipelago, links ECNs to boost their combined trading. In volatile markets, use limit orders. With the SEC cracking down--and brokers facing fines of $10,000 and up--dealers should do a better job of filling them. And don't be greedy: If you expect a stock to move and you really want it, bid aggressively to boost your odds. Most important, don't use MOOs. That's Street slang for ''market order on opening''--an order to buy or sell at the hard-to-predict price where a stock's trading opens in the morning. Not coincidentally, it's also the noise cattle make on their way to the slaughter. Use overnight limit orders, or stay away from the opening altogether: You'll have a better shot at avoiding a flaying in today's turbulent markets. By MIKE McNAMEE McNamee covers finance from Washington. _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP					RELATED ITEMS Commentary: Trading Online: It's a Jungle Out There TABLE: Best Bets for Better Trading INTERACT E-Mail to Business Week Online

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