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Faster Moves For Online Traders

Fortune Magazine

When Manhattan day trader Jim Walker put in a buy order this spring on E*Trade, the stock was at about 48. Forty minutes later the confirmation came back: He’d just paid 56. “You can never directly blame anybody, but to see an eight-point difference between the time I executed the trade and when I got it back, that’s very fishy,” Walker says.

More and more online traders these days are getting a nebulous feeling that they’ve just been had. They may be right. For all the supposed speed of the Net, online trades weave their way through a series of brokers before they actually hit the market, just like any other trade. And somewhere along the line some trades inevitably get delayed. That’s bad for traders–because time truly equals money when a stock price is moving away from you. “Missed execution is happening with alarming frequency,” says a Beverly Hills lawyer who represents investors in brokerage arbitration cases. That’s why traders such as Walker are looking to a new generation of professional trading software now being offered by a number of firms at prices nonprofessionals can afford.

To appreciate what the new programs do, you have to understand how old-style online trading works. When you place a trade on the Internet, all you do, in effect, is e-mail rather than phone your broker. The first obstacle to a quick trade, then, could be a simple Internet slowdown.

Once your broker gets your order, he can send it to a number of places to be executed, depending on the stock. If he has the stock in his inventory, he can trade with you himself. Another option is to go into Nasdaq and sell the order for about $2 a trade to a market maker–a process known as payment for order flow. Whoever ultimately does the trade is supposed to do so at the best available price.

While payment for order flow is perfectly legal and doesn’t necessarily mean higher prices. In a fast-moving market, a market maker is allowed to slow down the action–and thus protect his capital–by filling orders manually rather than automatically.

Columbia University law professor John Coffee also sees a potential conflict of interest in brokerage firms sending orders to their own electronic communication networks, or ECNs. The new networks lack liquidity, which could delay trades. “A lot of these are unanswered questions,” Coffee says. “We never had brokerages owning the New York Stock Exchange.”

How can the new software avoid these problems? Tradescape.com, for one, provides cut-rate access to Level II Nasdaq quotes, which show who’s bidding or offering, at what price, and in what volume. Users get to execute their own orders instantaneously from what’s available on various ECNs. For the less fanatic trader, CyberX (from trading firm CyberCorp.) automatically routes orders to the best price.

“Bill Gates says that the Internet is eliminating the middleman,” says Omar S. Amanat, CEO of Tradescape.com. “The regular online brokers have only taken the middleman’s place. We’re really cutting him out.”