Saturday, February 24, 2007

How To Be An Award-Winning Online Broker -- the long version

A week from today, the 12th annual Barron’s review of online brokers will be published.  The print edition will have about 4 pages devoted to the story, while Barron’s Online will contain expanded coverage.  The print edition, due to space constraints, will have a very short description of the criteria that went into the ratings.  Here is the long version, which I hope will show up in its entirety on Barron’s Online. 

Though this description repeatedly makes use of the pronoun “We,” think of it as a Royal We, with Yours Truly as the Queen. 

My goal here on InvestorBrain is to allow site visitors to create their own ranking scheme, weighting the criteria that matter to them the most.  Anyone know a good programmer?  grin

We ranked both web-based brokers and software-based by the following measures.

Trade Experience: Working with a live account, we looked for a real-time quote displayed, and executed equity trades during market hours, making market buys and limit sales of a stock or an ETF. Following the market buy, we evaluated the execution and portfolio reports. We looked for pre-filled order tickets when selling out of the position.  After entering the limit-sell order, we examined the open-order reports and looked at ways for the trader to follow the progress of the order, as well as ways to adjust the limit price or cancel the order outright. We also placed options orders, taking a look at the complex options order-entry screens when available. We also examined the mutual-fund, bond, and (when available) futures, commodities and foreign exchange order-entry screens.

We made deliberate mistakes when entering orders to see if the broker’s system would catch them and warn of errors such as inadvertent short sales or a limit price entered that was well away from the market. 

We broke the points awarded into several sub-categories, such as quality of the trading screen, design of order-entry screens for stocks and other types of investments and accessibility of order-status reports. 

An overall score of 5 in trade experience means the order entry-and-execution process flowed easily from one step to the next, with real-time information available when needed. The pre-order real-time quote is displayed without the need for additional keystrokes.  For software-based brokers, 50% was added to this score for the weighted total, to emphasize the need for well-designed and informative order-entry screens when trading quickly.

Trading technology: The availability of price-improvement strategies and smart-order routing technology, and the absence of internalized orders and a reliance on payment for order flow are necessary to earn a 5 in this category. Brokers offering price improvement-a sale above the bid price, a buy below the offer-received a fraction of a point depending on the percentage of their 4th quarter transactions were price-improved, based on data they are required to supply to the SEC. A broker that internalizes order flow for more than 25% of nondirected orders, and/or routed orders to receive payment for order flow above the industry average loses up to a half point. 

We also looked at the range of order types available, such as trailing stops and conditional orders; the option for customers to route their own orders; the ability to customize trading screens; provisions to enter multiple orders on one screen; and the ability to create baskets of stocks.

As with trade experience, the overall technology category was also given an additional 50% weighting for software-based brokers.

Usability: How easy was it to navigate around the site? Does the layout of the site, or the program design, make sense and minimize the number of mouse clicks it takes to get from one place to another? The key theme in this category is ease of use. We also looked at the ability to personalize each broker’s site. For example, can the welcome screen be customized? Can portfolio-analysis reports be altered to show items of importance to the individual investor?  For software brokers, was the installation process smooth? 

A 5 in this category means the site was easy to use and well-designed, doesn’t bog down when moving from screen to screen, and can be tailored to show what the user wants to see. The weighting was reduced by 50% for software based brokers, as their users are likely to invest the time it will take to climb up the learning curve.

Range of Offerings: We awarded points for the range of investments that can be traded online, with partial points given for those that can be traded only offline. Since all the brokers allow you to trade stocks long and short, and most allow you to enter single-leg options orders online, we don’t award points for those transactions.  We asked brokers how many stocks, on average, their customers can sell short, and awarded up to ½ point based on their answer.  Complex options trading, mutual fund availability, the availability of futures, commodities and forex trading were also considered. A 5 in this category means you can execute all of these transactions online.

We reduced the weighting in this category by half for software-based brokers since frequent traders usually focus on equities and options, usually not caring whether mutual funds or bonds are available online.  Frequent traders are, however, interested in trend analysis capability, the ability to enter trades that will be executed automatically, the ability to develop a trading system and apply it, and whether the broker’s fees are assessed on a per-share basis rather than per-trade, so we looked for the presence of those features and added them in this category.

Research Amenities: This category measures the quality and accessibility of research, quotes and charting. The highest points in this category went to brokers giving exceptional research and quote services. We evaluated the research amenities available to those with over $100,000 in their accounts, or who traded 36 times a year or more.

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 also won points for offering real-time streaming quotes at no additional cost, powerful charting capabilities, and Level II Nasdaq quote accessibility.

The weighting in this category was reduced by 50% for software-based brokers, based on reader comments, as many frequent traders indicate they use other tools for research.

Portfolio Analysis and Reports: The emphasis here is on clearly laid-out reports, updated in real time, showing current balances, positions and margin status. Portfolio-analysis reports, with links to news and research, as well as extensive transaction history, are most desirable.  We also favor systems that track the tax consequence of each trade and deliver thorough tax reports, including records of past transactions.  Real-time data and the ability to customize reports based on client needs are key to earning a high score in this category. 

The weighting in this category was reduced by 50% for software-based brokers, based on reader comments, as many frequent traders indicate they use other applications for analyzing portfolio performance.

Help and Customer Access: What happens when you decide you don’t want to go it alone? We sized up online help such as live-chat capability, user guides and frequently-asked-question files. Offline help was assessed by making calls to customer service, and based on the brokers’ reports of the average time spent on hold when a customer calls in. We also evaluated the availability of investing and trading education, both online and offline.  The ability to visit a broker in person, to place touchtone trades, or to place an order over the phone with a broker also factored in to this category. 

A factor added to this category this year is the rates a broker paid for a customer’s cash. 
This category also takes stock of brokers’ wireless-trading access.  The weighting in this category was reduced by 50% for software-based brokers since our frequent-trading readers emphasize costs and technology over hand-holding.

Costs: We looked at commissions for stock and options trades and margin interest rates, assigning higher points to lower costs. Stock commissions are the biggest factor here; this year we added mutual fund transaction fees to the rating as well.  We also looked at the cost of trading 10 options contracts; margin interest rates on balances of $25,000 to $50,000; charges for small or inactive accounts; and platform charges for software-based brokers.

A 5 in this category could be earned by a broker with very low stock and mutual fund commissions, of under $8.00 for 10 options contracts, margin interest rates below 7.5% and no account-maintenance fees. For the frequent traders who use software-based brokers, costs are even more important, so we doubled the weighting.

While each service was ultimately given an overall score reflecting all eight measures, those totals alone may not point to the right broker for you. If you’re interested in a few particular aspects of online trading, such as the best executions at the cheapest price, and don’t care so much about the availability mutual funds or bonds, consult the scores for those categories and find your own personal five-star broker.

Posted by twcarey on 02/24 at 12:43 PM
Published in Barron'sAnnual Broker Review • (0) CommentsPermalink