Investor Brain

Monday, March 06, 2006

11th Annual Review of Online Brokers

Different Strokes For ...

IT’S JUST ABOUT THE BEST OF TIMES for online brokers. As Barron’s prepared its 11th annual review, their assets and trading volume are up, and shares of major publicly held ones, such as Ameritrade (ticker: AMTD), E*Trade (ET) and Charles Schwab (SCHW), dot the new-high list.

But for clients of online brokers, there have been pluses and minuses. To be sure, they’ve enjoyed feature upgrades and continuing cuts in trading costs. But they’ve also had to endure occasional service glitches, especially as the industry continues its consolidation.

We examined 27 online brokers, which we split into two cohorts: 14 that use Web browsers and 13 that are accessed directly through their own proprietary software. Browser-based brokers work like familiar online retail or banking sites and appeal to the mainstream investor. Software-based brokers are aimed more at the serious, semi-pro trader willing to invest the time and effort needed to get a performance edge.

Based on input from more than 400 Barron’s readers, we tweaked many of the rating criteria, adjusting the weightings used in past years and varying them for browser- and software-based offerings according to their targeted users’ preferences. We assumed the customer had an online portfolio of about $100,000 and trades at least 36 times per year.

Two browser-based and four software-based firms earned 4½ stars out of a possible 5. In a remarkable display of consistency, optionsXpress (OXPS) tops the browser field with the highest point score for the fourth straight year. Next up is a newcomer, the Web version of thinkorswim’s offering. Six brokers earned four stars: Siebertnet, Ameritrade’s Apex offering, Fidelity Investments, E*Trade’s Serious Investor, TD Waterhouse Trade Central, and Scottrade.

Tied at the top of the software-based broker standings are two very different offerings from MB Trading and thinkorswim. TradeStation and Interactive Brokers also earned 4½ stars, while six firms garnered four: Terra Nova Trading, RushTrade, ChoiceTrade, Fidelity’s Active Trader offering, Fimat’s Preferred Trade and Schwab’s CyberTrader.

We rated all the brokers on such factors as the types of investments that can be traded through them online; the quality of screeners they offer to help pick stocks, options or funds; the usability of their trading screens; their sites’ ease of use and the reports they send to users, including printed monthly statements. We took a hard look at the types of orders that can be entered. For the software-based brokers, we delved deeper into trade automation, the ability to create a trading strategy and how commissions are calculated.

Not all these things might be important to you. Indeed, we’ve also tallied the best online brokers for two disparate groups—options traders and buy-and-hold investors. You may find your own 5-star broker, based on scores in your key criteria.

THE TOP DOGS: We can’t directly compare the top browser- and software-based brokers. We use different measurements for each group and rate some elements for each differently, too. But here’s a rundown on the brokers that earned 4½ stars.

On the browser side, optionsXpress again tops the list by providing a solid trading platform, opportunities for price improvement, a myriad of research tools and reports that let the client understand portfolio performance, as well as the tax implications of a trade. The only downside: The firm accepts payment for order flow for a large percentage of its options orders; critics say this raises questions about whether a broker will always send a trade to the site where it will be executed most favorably for a customer.

The designers at optionsXpress have a saying that guides their work: “A lot of littles equal a lot.” For instance, on a customer’s Positions screen, in-the-money options are highlighted in yellow, mirroring how options quotes are presented. In the quote box at the bottom of the screen, there’s a “More” link that lets you pop up a streaming quote, or click on charts. The site uses real estate wisely.

optionsXpress also offers ways to find additional trading opportunities. A new feature is Charting Patterns. It lets you examine both certain technical aspects of a stock’s price moves, plus fundamentals. Then, it displays charts of stocks that fit your criteria. To track taxes linked to your trades, optionsXpress customers now have access to GainsKeeper at a reduced price.

Next on the browser-based side is thinkorswim.com, which also topped our software-based list. In both forms, thinkorswim presents what its chief executive, Tom Sosnoff, calls a “sweet suite” of services. The browser product has almost all the bells and whistles of the software versioln. A client can use either version with the same login.

This platform edges out optionsXpress as our choice for high-volume options traders, and it has much to offer for stock and fund investors, too. Thinkorswim allows three free no-load mutual-fund trades each month; some other brokers charge $10 to $50 for the same number of transactions.

Thinkorswim excels in routing orders. From the trading page in both the browser and software versions, you can perform detailed pricing studies that show the risks and potential rewards of a particular trade. We like thinkorswim’s innovations, such as detachable and exportable windows, and data grids of charts or Level II data. Thinkorswim continues to overhaul its charting, and provides the ability to enter a trade from a chart. Its “Paper Trading” program lets users execute mock trades and see how they fare. Want to do multi-leg options trades? This is a great learning tool.

Both the browser- and software-based offerings are highly graphical and customizable, so this site might not be for someone who’s most comfortable with a text-based browser. But for sheer intellectual achievement, thinkorswim is a winner.

Tying with thinkorswim at the top of the software-based broker list is MB Trading, which excels in trade execution. Says executive vice president David Lipsett: “We consider this to be the most critical part of the trading process. The best research and information is pointless without superior execution.”

Table: Browser-Based Brokers and Software-Based Brokers

Table: Switch-Hitters

MB Trading has built a trading platform with fewer bells and whistles than thinkorswim’s, but which gives customers access to its smart router, MBTX, whose proprietary order-routing algorithms have been enhanced.

Though MB Trading is designed to appeal primarily to frequent traders, Lipsett says that it will produce offerings for less active investors. The firm prides itself on the level of customer help; phones are answered quickly by human beings, rather than computer-generated menus, and you’ll get help online within 15 seconds of logging into the chat area.

Also earning 4½ stars on the software side are TradeStation and Interactive Brokers, which reach out to very different varieties of traders.

TradeStation.com features an extensive suite of strategy-testing and implementation tools. It appeals to those who want to streamline and automate their trading. You can backtest a strategy using up to 25 years of minute-level data, which can offer a clearer picture than mere opening and closing prices.

Though you can enter orders manually, the TradeStation platform is geared for those who want to get deeper into the data and set up automatic trading. The Trade Execution Matrix, which displays a terrific market-depth graph, lets you enter orders quickly, and adjust them easily.

The strength of the platform is apparent in the Strategy Trading area. You can develop your own trading system, or use one that’s been developed by a third party (usually for a fee). Given the cost of using the platform, if you’re not going to utilize the trade-automation capability, TradeStation probably isn’t for you.

Last year’s software-based winner, Interactive Brokers, still garners 4½ stars, thanks primarily to the long list of trading possibilities and its rock-bottom pricing. IB targets sophisticated traders and investors who migrate after gaining experience at other brokers.

All trading takes place in a single window, the Traders Workstation, regardless of what is being traded. For options, any type of spread order with two or more legs can be created. Each leg of the spread is smart-routed to the market destination with the best price at the time of the execution decision.

Interested in trading international stocks and currencies? IB has a huge number of partnerships with exchanges outside the U.S. And its fees are extremely low.

THE BEST OF THE REST: The largest group of brokers we reviewed didn’t make the top tier. Most excel in a particular area or two, but fall short in others. Still, depending on your needs, your ideal broker could well be in this group.

Muriel Siebert’s Siebertnet’s major flaw: high pricing for options transactions. However, Siebertnet customers get free access to quite a few third-party research offerings for which other brokers would charge a fee.

The Bottom Line

The features offered by online brokers continue to proliferate, even as the industry consolidates. The best of the best boast ease of use, and a broad menu of services.
Muriel Siebert believes that price tiering creates inflexibility and doesn’t serve customers well. But her firm will negotiate rates with clients.

On the software side, Terra Nova Trading lets customers enter orders from within its customizable charts. Prices are updated, tick by tick, in real time. Users can change a limit order’s price simply by moving an indicator on a chart. Says Chris Doubek, Terra Nova’s president: “The ability to trade, change and view orders and positions within a chart is paramount, as they can quickly route orders, based on charting trends.”

That’s all we have room for now.

In coming Electronic Investor columns, we’ll look at some of the brokers who got less than four stars and at the trends that we believe will shape the industry’s future.

How We Ranked Them

WE RANKED ONLINE BROKERS’ SERVICES on the following measures:

Trade Execution: Working with a live account, we looked for smart-order routing technology, which finds the best bid or offer, and price improvement on limit orders—purchases or sales at specified prices. We executed equity trades during market hours, making market buys and limit sales of a stock or exchange-traded fund. We also placed options orders, using options- order entry screens when available. An overall score of 5 means the order entry-and-execution process flowed easily from one step to the next, with real-time information available when needed. For software-based brokers, a 50% extra weighting was added, reflecting the need for well-designed order-entry screens when trading quickly.

Trading Technology: The availability of price-improvement strategies and smart-order routing, and the absence of internalized orders and a reliance on payment for order flow were necessary to earn a 5 in this new category. Brokers offering price improvement—a sale above the bid price, a buy below the offer—received a fraction of a point, depending on how many transactions benefited. The overall technology category got an additional 50% weighting for software-based brokers.

Usability: A 5 here means the site was easy to use, well-designed and could be tailored to suit the user. The weighting was reduced by 50% for software-based brokers, as their users are likely to invest the time it takes to climb the learning curve.

Range of Offerings: We’ve changed the calculations in this category. Because all the brokers let you trade stocks, long and short, and enter single-leg options orders online, we asked brokers how many stocks, on average, their customers can sell short, and awarded up to a half-point, based on the answer. Complex options trading, the availability of mutual funds, bonds, futures, commodities, international equities and currencies were also considered. A 5 means you can trade all of these online. We cut this category’s weighting by half for software-based brokers, because their frequent traders usually focus on stocks and options.

Research Amenities: This measures the quality and accessibility of research, quotes and charting. We looked for research, news and charting linked to the customer’s portfolio and watch lists; the availability of third-party research and its integration with the rest of the site; and the availability of screeners, with special emphasis on options-strategy screeners. Brokers won points for offering real-time streaming quotes at no added cost, powerful charting capabilities and Level II Nasdaq quote accessibility.

Portfolio Analysis and Reports: The emphasis here is on clearly-laid-out reports, updated in real time, showing current balances, positions and margin status. The weighting was trimmed by 50% for software-based brokers, as many frequent traders use other applications to analyze portfolio performance.

Help and Customer Access: We sized up online help such as live-chat capability, educational features, user guides and frequently-asked-question files. Offline help was assessed by calling customer service and weighing the brokers’ reports of the average time a customer spends on hold. The ability to reach a live broker, to place touch-tone trades, or to buy or sell over the phone also was considered. The weighting here was reduced by 50% for software-based brokers, since our active-trading readers emphasize costs and technology over hand-holding.

Costs: We looked at margin rates and commissions for stock and options trades, awarding more points for low costs. A 5 could be earned by a broker with stock commissions under $40 for three roundtrips; under $17.50 for 10 options contracts; margin rates below 7.5% and no account-maintenance fee. Costs are particularly crucial for frequent traders who use software-based brokers, so we doubled the weighting in that category.

Published in Barron’s, March 6, 2006.

Monday, February 20, 2006

Seek And It Shall Find

IF YOU WANT SOMETHING DONE RIGHT, do it yourself: That credo led Pete Stolcers, formerly with Terra Nova Trading and now a professional trader, to come up with an interesting Website called OneOption (http://www.oneoption.com). Frustrated with existing investment-search technology, he hired a few programmers and created his own. He found that his technology generated too many trading ideas for one person to trade, so he decided to share it.

The site appears to be very simple to use, displaying the results of his searches in long lists of ticker symbols. His target user is a self-directed trader who is in the market at least twice a month and is willing to spend 15 to 30 minutes a day checking out opportunities. Stolcers uses this technology to trade 50 to 80 stock orders a day, and 2,000 options contracts.

The site presents the results of proprietary searches, which are designed to find short-term trading opportunities. The searches are organized according to four types: bullish versus bearish; time horizon of a day versus a week; price pattern displaying continuation or reversal; and confirmed-trade triggers versus early triggers. These patterns are combined into 16 different trading classes, such as Bullish-Weekly-Continuation-Confirmed (or BWCC).

Clicking on a symbol brings up a one-week chart; the user can pick a one-month or one-year chart if desired. The graphs, which are quickly displayed in a small box that overlays your main screen, are generated by Yahoo!.

The site is free through the end of February; in March, a charge of $7.95 to $12.95 per month will go into effect—depending on the level of service. The higher-priced versions include newsletters and additional search tools. OneOption provides some intriguing trading ideas for the day- or swing-trader; check it out.

WHILE THE DOLLAR’S STRENGTH CONTINUES to befuddle the experts, more currency-trading sites keep cropping up. The most recent to hit our radar is FX Solutions (http://www.fxsol.com), which has developed an automated trading system that maintains the spread between bid and ask at 3 pips (hundredths of a percentage point.)

What differentiates FX Solutions from many forex houses is that it doesn’t take the opposite side of its customer’s trade, a fairly common practice in the industry. Michael Cairns, FX Solutions’ head of trading, says, “Automation is a huge differentiator in the business, so customers can make sure brokers aren’t ripping off their customers. Most forex brokers trade against the customer since there’s no central book, like you’d find in equities trading.”

FX Solutions customers can define the size of the order they’ll place, and the amount of leverage they’ll use. Forex trading has become very popular with traders who are comfortable with a lot of risk, since they can trade up to 400 times the amount they’ve deposited. Risk management is a huge part of forex trading; and FX Solutions provides its customers tools that let them exit a position quickly if it’s turning against them.

As of early February, FX Solutions was allowing its customers to trade 20 currency pairs, 24 hours a day. The main screen displays the currency pairs available; entering a trade involves clicking on the side of the trade you want after predefining your standard order size. You can enter up to five stops to exit a trade—and in forex, it’s almost mandatory to set a stop-loss order when you enter a trade.

The platform includes technical charting and real-time data feeds. You can open an account with $250, or use the demo platform to get comfortable with the process before you start using real money.

FOLLOWING UP ON our tax-software column of last week, several TurboTax users let us know that the program has a limitation that affects very active traders. TurboTax can’t handle your Schedule D if the sum of all your transactions is $10,000,000 or more. There are also limitations to filing electronically if you have more than 200 transactions on your Schedule D.

WE’RE STILL BEING SWAMPED by e-mails about the Harrisdirect/E*Trade conversion problems. I’ve taken these complaints personally because most of the readers who wrote in hold me partially responsible for their experience. Back in 1999, DLJ Direct was the top broker in our annual roundup, and numerous readers opened accounts there as a result. When DLJ Direct became Harrisdirect, the changes were slight, and the transfer of accounts went smoothly.

Now they’re E*Trade customers, and they’re not very happy about it. Your intrepid columnist has spent a large chunk of the past month running down issues surrounding the conversion, many of which have been reported here. Our mailbox is still stuffed with complaints from former Harris customers who can’t figure out how to get a reasonable rate of return on their cash balances.

When I’ve shared those concerns with E*Trade officials, they’ve claimed that the new customers can get better rates of return on their cash and implied that the former Harrisdirect customers can’t easily figure that out. We apparently have a failure to communicate. Watch this space for updates.

Monday, February 13, 2006

Computing Your Taxes

Note:  This is a portion of the column that ran in Barron’s on February 13, 2006.  The original was co-authored by my Electronic Investor partner in crime, Kathy Yakal, but only my contribution is shown here.  Please reference the original to see Kathy’s thoughts on online tax prep sites.  She’s an insightful writer who also reviews financial software for PC Magazine. 

TAX-PREPARATION SEASON OUGHT TO BEGIN with a basic question: Should you do it yourself or hire the job out? If you feel that you’re educated enough on the ins and outs of filing your own return, with all the complications your life presents tax-wise, then pick up a copy of a tax-preparation program to help you out.

Filing a full 1040 long form by hand by yourself could qualify as proof of insanity, especially if you’ve done any substantial trading last year. Entering data on transactions—including dates, cost bases, sales prices—plus dividends and interest and then making the appropriate calculations by hand isn’t complicated, but it is extraordinarily and unnecessarily tedious. Plus, it all but invites errors on your returns.

If you have a relatively straightforward tax situation—salary, the typical deductions for mortgage interest and state and local taxes, plus simple investment returns—tax-software Websites should be able to handle your return without much complication. The program will ask you relevant questions; you fill in the answers as you go along. The interview process should cover most of the usual tax questions, and make suggestions along the way.

It’s not a substitute for a living, breathing professional if your tax situation isn’t pretty cut and dried. But if it is, it may be possible to download your relevant data—such as W-2s from your employer, 1099s from financial institutions, mortgage and property-tax-payment data from your bank—and let you computer do most of the work. If you prepared last year’s tax return on a computer, you can transfer basic data—name, address, Social Security number, dependents—into your new return, which also reduces the tedium. And if you’re organized and use personal-finance software, such as Intuit’s Quicken or Microsoft’s Money, the process can be further automated.

Tax software also can mitigate several other hassles of filing. If you are subject to the dreaded alternative minimum tax, the software will at least inform you of the bad news. Doing your taxes by hand may require a second set of calculations. If you’re subject to the AMT, it’s probably because you’re unlucky enough to live in a state with a hefty income tax, such as New York or California. The popular tax programs also have state versions, which take your federal data and prepare your state return with relatively little extra effort. Finally, tax programs can alert you to errors and omissions, and to situations that might invite an audit.

We took a look at the tax programs and online services available with an eye for how they’ll work for a relatively active investor. This year, we also looked at how the programs adapted to changes in the tax laws, as well as how they work for dealing with the home-office deduction.

The major names in tax-preparation software continue to be TurboTax, by Intuit, and TaxCut, by H&R Block. Both overhauled their interviews for the 2005 season; TurboTax’s was somewhat more successful; the program’s ease of use improved considerably.

TurboTax’s interview, which we reviewed using its Premier edition (list price $69.95, though many retailers throw in gift cards and other freebies), allows you to import data from financial institutions that use Intuit’s .OFX file. Importing data into TurboTax is an extremely smooth process, especially if you’ve got broadband Internet access. If your bank, broker or mutual fund is part of the network, as most major ones are, pulling in tax-related data is very easy. Many employers also are tapped into the network, either directly or via a processor such as ADP, allowing employees to import their W-2 data quickly and accurately.

We imported data from several brokerage accounts that have been supplied to us for our annual review of online brokers into TurboTax. One of our accounts has quite a few transactions in it, and TurboTax brought them all in flawlessly this time. We haven’t been as lucky in past years; this facilitated import is a huge improvement.

TaxCut doesn’t have the same import capability, however. You’ll manually enter all that data from those 1099 forms that your brokers have sent. We reviewed TaxCut Premium ($49.99 list, also with various goodies from major retailers), which includes H&R Block’s DeductionPro.

If you’re manually entering your stock transactions, be sure to use trade dates rather than settlement dates. If you sold a stock on Dec. 29, 2005, for instance, even though it didn’t settle until Jan. 2, 2006, it counts as a 2005 transaction. Most brokers send out a summary 1099, informing you of the proceeds from all of your transactions over the past year. You’ll need the detailed records of each transaction to be sure the dates and amounts are correct.

Both TurboTax and TaxCut did a good job of dealing with changes to individual-retirement-account contributions, and they examine whether you’re eligible for a Roth IRA rather than a traditional one. TaxCut’s extensive audio help points out that your traditional IRAs are exempt from bankruptcy filing, and encourages users to maximize their contributions, whether they’re deductible or not.

This year, TurboTax added quite a few ways to spend your refund, in the event you’ve given Uncle Sam an interest-free loan last year. You’ll be given the chance to purchase gift cards from a wide variety of retailers, at a discount, with your refund. We think a better use of your refund is to roll it into your IRA or other investment accounts.

If you’re new to tax software, TurboTax is the way to go. TaxCut users will be well-served by picking up the 2005 version unless you want to shift the data entry load over to your computer. (Either program lets you import data from the other’s preceding year’s return.) Check the TurboTax Website (http://www.turbotax.com) to see if your financial institutions are in its system.

FOR THE PERIPATETIC TRADER, neither TurboTax nor TaxCut will make the job of preparing your Schedule D easy, though. That’s where TradeLog and GTT TradeLog come in handy (http://www.armencomp.com). These programs, published by Armen Computing, help those who actively trade to generate portfolio-performance reports as well as prepare a Schedule D.

GTT TradeLog, which is supported by Green Trader Tax (http://www.greentradertax.com), is aimed at traders who need to track mark-to-market transactions. TradeLog is for all the other active traders. Prices range from $49 for a version that is restricted to 100 transactions, to $349 for the mark-to-market version.

The programs produce a file in TXF format that can be imported into TurboTax or TaxCut for preparing your entire return. We found that TurboTax handled the larger number of transactions more elegantly and with fewer errors.