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Is your broker getting you the best price?
By Jeff Ponczak
As direct-access trading has slowly gained more of a foothold in the
mainstream marketplace, its proponents have not been shy about touting it as
far superior to using a standard online broker.
In a nutshell, direct-access trading (using firms such as CyBerCorp)
eliminates the middleman and sends buy/sell orders directly to the exchange.
In many cases, an instant execution is possible. On the other hand, placing
an order through a standard online broker (e.g., E-Trade, DLJ) is akin to
sending that firm an e-mail. Upon receiving the order, they send it to a
third party for execution (see “The Direct Connection,” Active Trader,
August 2000, p. 28).
While the entire process at a standard broker often takes only a few
seconds, sometimes the market can move significantly in that period of time,
especially in a volatile stock. Therefore, the price a trader sees when he
or she places the “send” button is not necessarily the price at which the
trade will be executed. That, claim the direct-access brokers, is where they
have the biggest advantage.
If the Securities and Exchange Commission (SEC) has its way, all the debates
will soon end. In mid-November 2000, the SEC passed a pair of rules that
mandate disclosure of execution rates among market centers, and disclosure
of routing practices and payment for order flow among broker-dealers.
The new rules go into effect on April 2. When the first set of data comes
out, traders will be able to see whether orders sent through a particular
ECN are executed at a better price than those routed to an execution firm
such as Knight Trading. Or, whether trades sent through a direct-access firm
such as Tradecast are routed to the best price more often than those sent
through Ameritrade or Charles Schwab.
“I think that what is going to end up happening is that the individual is
going to take a look at all the different brokers,” says Peter Stolcers,
director of marketing for Terra Nova Trading. “The [traders] that are
concerned about the types of fills they are getting are going to evaluate
their broker and how often they route to a particular area and how well that
area or market center actually executes the trade. Then they are going to
see the other market centers’ performance. If they feel that they can
consistently be getting a better shake somewhere else, then ultimately the
only way for them to route to that market center consistently is to engage
in some kind of direct-access platform.”
For example, the study may show that Broker A is directing 80 percent of its
trades to Market Center A, who is getting the best price 50 percent of the
time. If Market Center B is getting the best price 90 percent of the time,
that may cause traders to switch brokers to one that is consistently sending
its orders to Market Center B.
However, while the information will now be available for everyone to see, it
won’t necessarily provide all the answers. There are numerous reasons a
particular broker would route an order to a particular center, and the
disclosure numbers will only provide the tip of the information iceberg.
“The individual traders still have to roll up their sleeves and make the
interpretation on whether or not they feel their brokers are really
searching out the best possible price, or whether they are just routinely
routing to a particular market center and just taking as gospel the fact
that [the market center] tells [the broker] they offer the best prices,”
Stolcers says. “That to me is the true issue.”
Also, best execution is not necessarily the top priority for all market
participants.
“Giving investors more information is always a good starting point,” says
Stuart Kaswell, senior vice president and general counsel of the Securities
Industry Association. “What we did not want to have happen was for people to
misunderstand what these numbers mean so that they think they mean more than
they actually do.
“There could be 100 reasons why you pick a marketplace, but defining best
execution is a little bit like defining a best meal,” he says. “When you’re
in the mood for a pizza, the best steak around doesn’t matter. If you’re an
individual investor, and all you’re looking for is to get rid of 100 shares,
the thing you may value the most is speed. You might not be worried about
opportunities for market improvement. You would like it, but given the
choice you may want speed more than anything. If you’re a major institution
and you’ve got 1 million shares, speed is the last thing you want. You need
somebody who is going to work your order and make sure it doesn’t have an
impact on the market.
“The (execution) statistics are not like airline on-time arrival data,”
Kaswell says. “It’s not black and white.”
Much has been made of SEC Chairman Arthur Levitt’s statement in July 2000
that 85 percent of Nasdaq market orders were being routed to markets that
don’t have the best price. That doesn’t automatically mean that the orders
were being executed worse than the best price (known as a trade-through),
just as routing an order to the market center that does have the best price
doesn’t automatically mean a trader will get that price.
“Even with the algorithms of the ECNs (Electronic Communications Networks),
which automatically route to the best price, by rule and regulation a NASDAQ
market maker has 20 seconds to respond to the order,” Stolcers says. “So
even though he was the best price at that particular snapshot in time and
even though the order was routed to that best price at that particular time,
in 20 seconds there could be a better offer that enters the marketplace and
gets filled at a better price. So even though you route it to the best
price, you don’t necessarily get the best execution.
“If there were rule changes where the NASDAQ market makers had to
instantaneously honor the market and there wasn’t any latitude for that to
happen, you could pretty much say if it routes anywhere in the open market,
it will be the best price because it executes instantly,” he explains. “When
the order is executed within the ECN order book, if they were showing the
best price and the order was routed there, you would have a high degree of
certainty in saying that was the best [execution].”
Of course, not everybody desires more information — or for that matter
understands it. A segment of the trading population (albeit a segment that
is more accurately described as investors) likely doesn’t understand the
difference between direct-access and standard online brokers, and therefore
will likely not be able to make heads nor tails of the information requested
by the SEC. And, the most active traders who would likely benefit the most
from the disclosure are in almost all circumstances already using
direct-access brokers.
It’s been mentioned over and over — on a trade of 100 shares, getting an
order executed at one-eighth worse than the best price costs $12.50. For the
short-term trader making numerous traders per day, that’s suicide. For the
investor making five trades a year and holding stocks for an extended period
of time, it’s insignificant.
Plus, as Kaswell points out, the responsibilities of a broker-dealer aren’t
changing because of the rule.
“As this [rule] adds public awareness to the discussion, that’s absolutely
fine,” he says. “But you must remember that brokers have long had a duty of
best execution to their customers, and the regulators have been very
vigilant about saying to broker-dealers during inspections, ‘And you’re
routing to this marketplace why?’ If you aren’t in a position to defend, you
’re going to have some explaining to do. The more [information] the merrier,
but has the broker’s duty of best execution been there as long as there has
been agency law? Yes. There’s nothing new about that.”
In today’s litigious times, a market center that routinely executes at less
than the best price would surely catch the eye of a dollar-minded securities
lawyer. The SEC anticipated this, adding a provision to the rule that the
information disclosed could not be used as the basis for a lawsuit.
Likewise, the rule isn’t intended to make any particular broker or market
center change the way they operate. However, it is certainly possible that
some brokers will reconsider their routing practices (and some market
centers their execution practices) if the findings lead to customer
backlash. The end result could be a reduction in the number of
trade-throughs, although Kaswell would like to see further steps being
taken.
“We think market linkages and a market-wide trade-through rule are the next
logical step to move forward to prevent trade-throughs,” he says. “The SEC
is doing good work on the linkage issue in the options market. We would like
to see some of that good work in the equity part of the business so there
would be better linkage among the markets, and that would lead us quickly to
a trade-through rule. That’s where I think we should be headed.”
-----Original Message-----
From: owner-metastock@xxxxxxxxxxxxx
[mailto:owner-metastock@xxxxxxxxxxxxx]On Behalf Of Frans Derksen
Sent: Apr 04, 2001 10:48 AM
To: metastock@xxxxxxxxxxxxx
Subject: Re: Discount Stock Broker Evaluation
Please explain: The difference between direct access brokers and
web-brokers.
Thanks,
Frans
At 09:25 4-4-2001 -0700, you wrote:
>Save yourself a lot of frustration and losses and go to a direct access
>broker that supports realtick or something similar. TerraNova,
>EquityTradingonline, Cybercorp spring to mind as good ones, although since
>Schwab bought out Cyber, their reliability has been going downhill and
>their commissions haven't gone down, so the first two are probably better
>bets. Unless you plan to trade purely on end of day data and don't care
>as long as you get filled within $1 or so of your target price, even the
>worst direct access broker is infinitely superior to web brokers.
>
>At 07:01 AM 4/4/2001 -0800, you wrote:
>>I am thinking of using a discount firm to trade on the internet. I would
>>appreciate any pro and con opinions and experiences of using ETrade vs
>>Ameritrade vs TD Waterhouse as a discount broker. Schwab is not to be
>>considered. Any other firm suggested could be considered.
>>If the MS members feel that the response is not MS related you can email
>>me directly at linoaalessi@xxxxxxxxxxxxxx
>>Thanks and successful trading
>>Lino
>
>
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