Investor Brain

Monday, January 23, 2006

Lost in Translation

THE HORROR, THE HORROR.

The conversion of accounts from Harrisdirect to E*Trade, which took place between Jan. 10 and 13, turned into a disaster. As noted here last year ("Lowering the Velvet Rope,” Aug. 15.), E*Trade Group benefited in this deal by getting the affluent clients of Harrisdirect. Those folks apparently have made out less well.

Our Electronic Investor e-mail account swelled with reports from unhappy former Harrisdirect clients, telling us of problems logging in, disappearing cash, positions reported incorrectly and hours on the phone waiting on hold after the changeover.

Jarrett Lilien, president and chief operating officer of E*Trade Group (ticker: ET), told us customers with multiple accounts linked to a single log-in had been sent materials telling them how to update their passwords. That system hit what Lilien called “a roadblock” and ran very slowly, which made customers think that their accounts were no longer available or had been lost. These customers called the E*Trade support lines for help.

The conversion also involved changing clearing firms, from Pershing to E*Trade’s own system. This required E*Trade to run both systems concurrently for three days while the data were moved over.

E*Trade had hired several third-party firms to manage some of the data conversions, and although tests prior to the conversion worked fine, on the actual date they failed. The affected customers, who thought that positions had gone missing, also called the support lines for help.

Another problem arose when the cash held in Harris accounts was moved to E*Trade. Owing to the difference in database technology, the cash was logged as transactions, which could trigger backup withholding for tax purposes. The third-party vendor hired by E*Trade had turned off tax withholding for those transactions, but apparently turned it back on prematurely.

As a result, numerous customers got a shock when they looked at their balances, thinking that a chunk of cash had disappeared. This error was fixed within a few hours, but in the meantime, affected customers flooded the E*Trade support lines to find out what had happened.

E*Trade had doubled its support staff for the week, but the series of problems generated seven times the usual number of calls. That created a huge backlog and a lot of unhappy new customers. Says Lilien: “We’re secure, the money is still there, but we didn’t handle the conversion right.”

On Jan. 15, the customers transferred from Harris received an e-mail from E*Trade that said: “Although the majority of Harrisdirect customers have migrated to E*Trade smoothly, there were customers who experienced significant frustration. To those customers, we apologize sincerely.” The e-mail said the problems that erupted during the conversion have been addressed and corrected, with the exception of the long hold times on the phone.

To make up for the inconveniences, former Harrisdirect customers will be given credit for up to five stock or option transactions that they execute between Jan. 17 and Feb. 16. We shall see whether a $65 discount in commission costs will keep these customers on board.

E*Trade’s intention in acquiring Harrisdirect, as well as BrownCo, is to be viewed as a financial partner for those with high-account balances. The firm has added Credit Suisse First Boston research for those with over $100,000 in assets, and is building out an advanced aggregator for research for those customers.

On Jan. 17, E*Trade announced that customers would be protected from online fraud via the firm’s Complete Protection Guarantee, which provides fraud coverage, bill-payment protection and privacy protection. Surveys show that customers believe that their home PCs are safe, when in fact they may be lacking some key protection.

E*Trade has enabled two-factor authentication for those who want it, which means requesting a key fob that generates a random number that the user types in to log into an account—an approach that’s used with many corporate networks. The Complete Protection Guarantee is an extension of banking protections, already in place, to the brokerage side of the business.

If you have a Brown account, should you worry about the conversion? E*Trade’s Lilien says that the Brown conversion should go considerably more smoothly because both brokerage firms already run the same computer systems. We’ll see. The switchover is scheduled for some time in the first quarter.

Monday, January 09, 2006

Not-so-Foreign Exchange

EVEN IF YOU’RE FAMILIAR with trading equities and options online, venturing into the wide world of currencies can be daunting. After all , you’re suddenly trading against professionals with your (relatively small) retail account. No less an investor than Warren Buffett, who famously bet against the dollar, can wind up on the losing end of currencies.

Into this void steps COESfx (http://www.coesfx.com), which has created an electronic-communication network for currency trading that’s patterned after the more familiar equity ECNs, such as Archipelago or Island. COESfx’s book looks like a Level II ECN, where the best bid and offer float to the top.

Mike Weiner, COESfx’s co-founder and managing partner says, “All customers—from mom-and-pop to large hedge funds and institutions—trade on the same platform. There’s no separation between platforms.”

The system takes quotes from multiple dealers and sifts through them to present the customer with the best bid and best offer. Weiner’s background is in equities, which is why the firm built its model this way.

On the main page, COESfx displays four currency pairs with real-time pricing. The firm offers 22 currency pairs, plus spot gold and spot silver. Weiner says that a key difference between COESfx and other online currency-trading firms is that his firm doesn’t have the ability to manipulate the spread; the platform can only display what the banks are passing through.

COESfx charges a transaction fee, rather than taking the spread, as most platforms do. The fees charged vary, based on volume. In 2005, customers were charged, at most, $10 per $100,000 traded—but Weiner says the firm plans to cut that to $7.50 early this year.

New customers can open an account with $5,000, then use leverage, comparable to trading on margin, to trade 50 times that amount. Weiner says that 50-to-1 leveraging is relatively low in the currency-trading industry. He has seen 400-to-1 leveraging (investing with borrowed money), but believes that can kill the beginning trader. “We recommend that when you start out, you use at most 5- or 10-to-1 leverage. The less leverage you use, the less exposure you have.” There are no additional fees for using leverage.

COESfx has set up risk-management tools so that nobody will have a margin call where they have to come up with additional funds. Weiner says that when a customer has a loss of 80% of their starting daily volume, they get stopped out. With $10,000 they can buy $500,000 of currency but their exposure is only $8,000.

You can sign up for a demo account, which displays trading through just one of the banks available. But depending on the currency pair, you’ll still see a good depth of market with the one bank. The platform is Java-based and, similar to direct-access brokers, must be downloaded and installed on your computer. A high-speed Internet connection is most helpful both with the download and with running the platform once it’s installed. (But if you’re still using dial-up, you probably shouldn’t be trading online.)

There are other ways to get in touch with your inner Warren Buffett. The first currency exchange-traded fund—the Euro Currency Trust (ticker: FXE), which tracks the euro’s exchange rate against the dollar—began trading last month. In addition, EverBank (http://www.everbank.com) offers money-market accounts and certificates of deposit denominated in an array of currencies (including the Icelandic krona, which yields over 8%) and gold.

FIDELITY (http://www.fidelity.com) has updated its Wealth-Lab Pro tool, which is available to customers who qualify for Active Trader services (120 trades per year). Wealth-Lab allows traders to design, build, back-test, and execute customized-trading strategies.

The main pieces of this upgrade are a new user interface and a “wizard” that helps the user build a trading system. Also new is the ability to plug both fundamental corporate data and technical indicators into a model, which is unique as of this writing. (TradeStation plans to add fundamental data to its trading systems in its next release, due out in the spring.)

There are several steps to building a trading model. First, you define the stocks you will be examining by setting up a watch list. You can create numerous lists, and mix and match them as necessary. Then, you define the specifics of the model, which can include both fundamental and technical data, plus your entry and exit points. The wizard then generates the code to run the model; if you want, you can manually modify the code.

Once the model is built, you run it on historical data to see how it works. Wealth-Lab Pro builds tables of results, letting you compare the model’s performance to a simple buy-and-hold strategy, as well as utilizing margin. One key enhancement to this version is that you can tell the model to only buy and sell in round lots—the prior version might have told you to buy 362 shares of a stock at one entry, then sell 278 at the next exit.

If you qualify for active-trader status at Fidelity, Wealth-Lab Pro is a terrific tool to use to build and test trading strategies. The truly brave can let it automatically execute trades as well.

Monday, December 26, 2005

New Kids in Town

THOUGH 2005 HAS FEATURED SERIOUS consolidation in the online brokerage industry, some brave souls are still starting up new firms, dangling enticements such as low prices or different ways to invest.

One that might appeal to the cost-conscious investor is TradeKing (http://www.tradeking.com), which features commissions of $4.95 per equity transaction, and $4.95, plus 65 cents per contract for options. The firm was started by a group that in the 1990s founded Suretrade, which at the time was one of the low-price leaders, with $7.95 trades. Suretrade eventually merged with Quick & Reilly’s online brand, which was part of Fleet Financial; Fleet since has been absorbed by Bank of America.

"Over the past couple of years, we’ve felt, with all the industry consolidation going on, that online investors are being neglected,” said TradeKing’s co-founder and CEO, Donato Montanaro. “We came together and said, ‘We can do better.’”

Montanaro, when putting together the package for his potential customers, wanted a pricing scheme that is easy and understandable. He feels that tiered pricing is confusing and divisive, so the firm’s commissions are a flat $4.95, including trades placed with a live broker. Margin interest is also flat, currently at 6.75%, regardless of the outstanding balance. The firm also eschews fees for low balances or lack of activity. “We despise hidden fees,” says Montanaro.

The Electronic Investor was given a preview look at the site prior to its public opening on Dec. 19. At the initial login, the customer is presented with a Summary page, which can be customized. The main menu is displayed at the top of the screen; additional choices display as your mouse rolls over the menu boxes.

The site has quite a few features that will appeal to options traders, including a way to build multi-leg options that displays the net delta—a measure of risk—of a potential position. You can select the strategy you’d like to look for, such as a “calendar call spread,” and it will find contracts that fulfill your needs.

Another interesting feature for options chains is that the pricing is displayed as bid, ask and “mid.” If you click mid, a trade ticket is populated with the price between bid and ask, rather than assuming that you’ll buy at the ask and sell at the bid. Montanaro says this feature is designed to save investors money on their trades, since the price they can get is more to their advantage.

Filling out an order ticket can take several pages, however, including a step that has disappeared from most online brokerages: entering your password to confirm the placement of an order. You can turn that requirement off if you’d like.

The Holdings page lists your current positions; each option contract has a checkbox to its left. If you’re in a multi-leg option, you can click on the box for the various legs, and then identify the strategy for that group of options—for example, a “butterfly.” Clicking on the strategy opens a multi-leg trade ticket with the symbols filled in that will allow you to close the position quickly. The way it’s organized forces the trader to remember which strategies have been employed, however.

Another research tool that provides intriguing results is the Probability Calculator, which shows the odds of success for a given strategy. To use this, you enter a stock symbol, and the date in the future for the calculations. You can also estimate two potential future prices, perhaps representing your stop-loss and your desired gain. The tool shows the probabilities of the option expiring at the underlying price shown, which also translates to the stock reaching the prices you’ve entered.

TradeKing is also introducing some community-building features, such as blogs and rankings of articles of interest to customers. The firm says it will offer downloadable educational podcasts, and will also track the truth of what bloggers post to avoid pump-and-dump scams.

Setting up a quote watch list is a little clumsy. Users have to type their desired symbols into a box in the Setup area; it would be easier to use if you could design the watch list while you’re looking at a quote screen, which is the method used at most brokerage houses that allow user-specified watch lists. Similarly, customizing reports has to be done from the Setup area rather than while viewing the report itself. These sort of issues, however, aren’t unusual for a brand-new offering.

If you’re cost-conscious, want to work with an investing community and are willing to deal with a few startup idiosyncrasies, check out TradeKing.

ANOTHER START-UP, aimed at those focusing on exchange-traded funds, is XTF Advisors (http://www.xtf.com). The firm, which launched its Website in mid-September, is offering both online brokerage accounts and separately managed accounts (SMAs), and has set themselves a lofty goal: to change the way Americans invest.

The first two options are implemented through XTF’s self-directed brokerage service. If you want to go it alone, you pay $14.95 for online transactions, and the Website functions much like a traditional online brokerage—albeit one that focuses on ETFs. You can also go through one of the asset-allocation programs on the Website and pay a fraction of a percent of your account value. This latter approach is similar to Ameritrade’s Amerivest and requires an opening deposit of $5,000.

The third option is to open a separately managed account with a minimum of $50,000 and let the advisers at XTF manage your portfolio for you. They use a specialized ETF planning tool to set up your initial investments, then rebalance the holdings periodically. This approach costs an annualized 0.65% of your account value, due in quarterly payments. If you have $100,000 in your account, you’d pay $650 per year, or $162.50 quarterly, but you would not be charged individual transaction fees.

The site offers several ETF screeners, free of charge, based on MarketWatch and Lipper data. Once you’ve built a potential portfolio of ETFs, you can backtest their performance against other types of investments. XTF’s proprietary econometric model substitutes indexes for the ETFs to simulate how an index-based ETF would have behaved in the years prior to its existence.

Sander Gerber, XTF’s Chairman and CEO says that the company is in the middle of an internal study about the tax efficiency of mutual funds compared to low-cost index mutual funds and ETFs. He says that “The bottom line is that as the population of mutual fund holders drops the remaining holders will take the hit on capital gains.” The firm plans to summarize the conclusions on its Website, with the intention of educating investors about the tax inefficiencies of mutual funds.

XTF’s President Robert Adler says that the firm is setting up a mutual fund analyzer that lets clients compare mutual funds with ETFs. Punch in the ticker for a fund and the tool will show an analogous ETF and compare the performances. Adler says the tool is ready, but there are still some regulatory issues to overcome.

Gerber says, “We’re not looking to be a trading shop. We want people who buy and hold. Our website exists to guide people into ETFs as investors—not traders.”