Investor Brain

Saturday, July 04, 2009

Shedding New Light on Dark Pools

Do dark pools pose a danger for retail investors?

JUST THE NAME SEEMS SINISTER. DARK POOLS of liquidity sound as though they belong in a Gothic novel, not on Wall Street. And indeed, many individual investors view them with apprehension.

What is a dark pool? It is a fluid, private institutional stock market that trades large amounts of shares outside of normal stock exchanges. Anonymous participants can enter orders that, if matched by others in the pool, get executed. The price of the trade has to be at or between what’s known as the national best bid or offer (NBBO).The total size is never disclosed. Although no one is quite sure, it is believed as many as 40 or 50 dark pools exist at any given time, run by big brokerages, major stock exchanges and independent outfits, among other sponsors.

Such pools allow big investors to move large amounts of stock without affecting pricing in the general public marketplace. Were they to sell the shares on an exchange, they would either have to accept lower bids from investors who can see they are selling, or break the transaction into tiny pieces, thus accepting lots of different prices and taking up a lot of time.

Dark pools negate transparency; they also provide pricing and other benefits to the biggest institutions that the small investor can never hope to see. As such, the Securities and Exchange Commission, under new commissioner Mary Schapiro, is considering forcing a little more light into this marketplace through regulation—if it doesn’t ban dark pools completely.

“Large institutional investors, on a pre-trade basis, don’t want to tell everyone what they’re doing,” says Tim Mahoney, chief executive of BIDS Trading, an industry-sponsored service for block traders. He adds: “Before you place a trade, the fewer people who know your intentions, the better price you’re likely to get.” Once a trade occurs, it is reported within 90 seconds, but it is hard to tell from reports where the trade was executed.

Taking the little guy’s side, Chris Nagy, managing director of order routing, sales and strategy for TD Ameritrade (http://www.tdameritrade.com), says, “I think dark pools are an excellent example of a market structure that gives institutions a way to prey on unsuspecting retail clients,” because they have more access to liquidity.

Not too long ago, almost all trading was dark, since there was no public listing of transactions. William O’Brien, CEO of DirectEdge, a market center based on automated-order matching technology, (http://www.directedge.com), says the ability to trade a stock off an exchange has been around since 1979. “It used to be a cigar-chomping sales trader who would take calls from a select few clients and play golf with cronies a few times a month,” O’Brien says. He observes that during the last few years, off-exchange trading has become a lot more automated: “It has gone from a cigar-chomper to a server with a snazzy name.”

DARK POOLS NOTWITHSTANDING, no one disputes retail traders have come a long way in recent years. Today, they have access to price data and trading capabilities that only professionals had a few years ago, and much of that information is free.

Several online brokers, including Interactive Brokers (http://www.interactivebrokers.com) and ChoiceTrade (http://www.choicetrade.com), allow retail clients to enter orders in ways that mask their true order size. And online retail-broker Sogotrade (http://www.sogotrade.com) routes customer orders to a variety of dark pools, including Credit Suisse’s version, Crossfinder. Sogotrade CEO Dave Whitmore says, “Our experience has been fantastic. We’re executing cheaper, my customers are getting good trades, and we’re able to keep our commissions low, at $3 per stock trade.”

Retail investors benefit in other ways, too. BIDS’ Mahoney notes mutual funds use dark pools, thus helping their individual-investor customers keep costs down.

Regulation NMS required brokers to route their orders so that trades are executed at the NBBO. Exceptions to the display’s provisions led to the creation of what we now call dark pools. The measure was passed in 2005, and implemented in 2007. It has had some important effects. One is that most NBBO prices visible on screens are for very small order sizes, like 100 to 500 shares. With large blocks of stock trading away from the visible markets—estimates range from 10% to 25% of total volume in heavily traded stocks—it is difficult to tell what the actual market price should be.

Although it is too early to say for sure, one worry is that, with large chunks of stock-trading occurring in dark pools, the spreads—the difference in price between the bid and the offer—will widen.

IN ANY EVENT, THERE now are so many electronic bourses that the overall market is becoming very fragmented.

Adam Sussman, director of research at the TABB Group (http://www.tabbgroup.com), doesn’t think fragmentation affects retail players who are executing relatively small orders, say a few hundred shares at NBBO, and says retail clients are likely to get price improvement on their smaller orders: “Fragmentation is probably a positive, because there is bidding going on for liquidity providers, to get that retail flow.” As long as online brokers are doing what they should—negotiating terms to receive better executions in exchange for their order flow—retail traders should benefit. “Fragmentation is just another way of saying ‘competitive market,’ “ opines Sussman.

TD Ameritrade’s Nagy counters that there are a lot of transactions in dark pools that retail can’t interact with. “As you take volume out of the marketplace, of course you’re not giving that little guy any sort of transparency,” he says.

DirectEdge has applied to the SEC to become an exchange. Its Enhanced Liquidity Provider (ELP) offers access to non-displayed liquidity pools right in its smart-order router. So an order that utilizes ELP can access dark pools, while maintaining the possibility of getting filled on the exchanges as well, says O’Brien.

Providing complete information about orders routed to dark pools would require a great deal of regulatory oversight—which institutions and retail clients would probably rather avoid. Should it happen, my guess is that the institutional traders will find another way to keep their order information from being publicly displayed. ELPs, which sweep orders through both displayed and nondisplayed markets, appear to be the best solution for all players, given the current state of technology and regulation.

Published in Barron’s, June 29, 2009. 

Saturday, June 20, 2009

E*Trade Upgrades Its Tool Kit

E*Trade and Scottrade introduce helpful new tools.

WE HAVE TAKEN NOTE IN THE PAST OF THE overwhelming amount of data, filters, and tools on E*Trade’s Website (http://www.etrade.com). We have also criticized the site design that makes it all so hard to find. We may have to drop the criticism.

The firm introduced in May its Investor Resource Center, which gathers together tools, articles, calculators and advice about how to find your way (financially) through various life events. “We are acknowledging that customers are expert in some areas, but not everything, so we are helping them with their whole financial life,” says Liat Rorer, vice president of product development.

Then, in early June, E*Trade introduced Online Advisor, a questionnaire and several related tools lassoed under one menu choice, which is found by clicking on Research and Guidance off the broker’s main page. These make it possible for an investor to develop her own action plan. And it is available to customers and non-customers alike at https://us.etrade.com/e/t/cio/landingpage. However, only current customers can take the last step: When you are finished with the tool, you can, with a click, buy the recommended portfolio—if you have an existing E*Trade account.

The questionnaire, which is the heart of the Online Advisor, takes you through a risk-profile assessment (essentially establishing your appetite for risk), then a financial profile, which includes your income, net worth, and liquid assets. After that, you are asked what types of investments you prefer; then an asset-allocation chart is drawn that compares your current assets to the recommended holdings.

Afterward, you are asked, “How would you like to proceed?” You can invest an entire existing E*Trade account to match the recommendation, talk to an advisor, or open a new account and fund it to create the recommended portfolio. E*Trade provides six possible investing solutions for a customer: Build Your Own; Fee-based IRAs [individual retirement accounts] offered via a wealth manager; a session with a financial advisor; or one of three other online options.

The online options are a Select Mutual Fund Portfolio, which is a group of diversified mutual funds, and two exchange-traded-fund (ETF)-based solutions. The Select ETF Portfolio offers up one of seven portfolios that include a variety of ETFs that the investor manages on her own. The other choice is a Managed ETF Portfolio, for the investor who would like to have E*Trade keep an eye on it and rebalance it when necessary. The fee for a Managed Portfolio is 50 to 75 basis points (0.50% to 0.75%), depending on the size of your initial investment (minimum $10,000).

Rorer notes, “We are launching this tool as we are getting big inflows of customers from full-service brokerage firms looking for more guidance and context around their investments. The investors we have had for years also need this.”

If you have an E*Trade account, you can see your allocation graph in your Accounts Summary, and keep track of how you are doing in relation to the recommendation. I found this tool very easy to use and, for an investor who wants some hand-holding or some investing ideas, it is well worth checking out.

Note: Last week it was reported that E*Trade and its largest shareholder, hedge-fund Citadel Investment Group, were working on a plan to shore up its finances owing to problems in its banking unit.

GOING MOBILE: Scottrade has rolled out a mobile-trading application that can be used from any Internet-enabled mobile device; it isn’t necessary to download and install an application. Point your device’s browser to m.scottrade.com, and you will see the log-in screen. We got a demo of the mobile app, which we tested on an iPhone.

Kevin Dodson, director of online financial services, says, “Our new mobile-trading site is designed to make it as easy and seamless as possible for Scottrade customers to transition between their desktops and mobile devices, without sacrificing the research tools they need for the convenience they want.”

Scottrade customers can use the site for free, and view account information—including balances, order status and positions, trade stocks and exchange-traded funds (ETFs) with market, limit, stop, stop-limit and trailing-stop orders. There is also a rudimentary stock screener built in, which links directly to a trading screen that lets you hone in on price, a few fundamentals, and market segment.

Most of the features of the mobile app can be found using push-button bars or drop-down menus. You will have to type in ticker symbols, except for those already in your portfolio. Quotes are displayed in real-time along with a intraday price chart.

Options trading (with market, limit, stop and stop-limit orders) is also possible, but you will have to know the entire ticker symbol in order to place a trade. Getting an options quote is a little clumsy; first look for the stock quote, then select “Options” from the drop-down menu. You can only view one strike price/expiration-date combination at a time, and only simple options orders (single-leg) can be placed.

This mobile application looks like a good start, and it is certainly simple to use. I look forward to the next generation.

MYSPACE FOR TRADERS? TraderPlanet (http://www.TraderPlanet.com), a social-networking site for active traders and investors that launched this past January, rolled out an upgrade of its Website last week. TraderPlanet.com offers members a suite of market data feeds, technical analysis tools and analyst commentary across asset classes. Members can discuss matters of interest in forums, under the community tab, with topics such as exchange-traded funds, futures, foreign exchange/commodities, options and stocks. You can also discuss approaches to trading; the strategy-trading topic is the most active on the site.

One feature sets TraderPlanet apart: It encourages members to use some of their trading profits to support charities.

TWEEPLE TO FOLLOW: Tim Knight, founder of Prophet.net and ProphetCharts, is a technical-analysis-chart maniac who can be found here: Twitter@ slopeofhope. Tim also has an interesting blog at http://www.slopeofhope.com, which is an entertaining and educational look at the market through the eyes of a day-trading techie. Disclaimer: Tim lives down the street from me, and is a good neighbor.

Published in Barron’s, June 15, 2009. 

Saturday, June 06, 2009

Nice Add-On -- or Google Buster?

SMART INVESTORS STRIVE TO STAY INFORMED about all the sectors and individual stocks in play. But the sheer volume of information you can find while wandering online can be daunting. So finding tools that winnow available information into a useful format is a big plus.

A new service debuted on May 18 that can keep data nerds (like me) clicking away for hours. Wolfram/Alpha (http://www.wolframalpha.com), which calls itself a “computational knowledge engine,” collects interesting data tidbits from a variety of sources. It not only provides answers, but offers additional context and related info. Although mostly impressive, the results can be confounding.

For instance, a query that didn’t compute was “MSFT options,” which resulted in a screen saying, “Wolfram/Alpha isn’t sure what to do with your input.” But “gold futures” gives you the recent price chart, and a volatility graph.

I found it most useful for collecting fundamental data on a publicly traded company, and for comparing side-by-side the financial performance of two companies like, say, Apple and IBM. You can see a list of examples of what is currently possible by going to the Money and Finance sample page at http://www44.wolframalpha.com/examples/MoneyAndFinance.html.

ANOTHER GOOD STARTING POINT FOR THOSE interested in seeing what can be done on the site is founder Steven Wolfram’s overview video; there is a link to it at the bottom of the “New to Wolfram/Alpha?” box on the right-hand side of every page.

Wolfram, who received a Ph.D in theoretical physics at age 20, launched Wolfram Research in 1986 and published the program on which the Website is based in 1988.

Millions of pixels have been spilled discussing whether Wolfram/Alpha is a “Google Buster.” I’ve seen dozens of comments characterizing the site as “a cross between Google and a calculator,” but I disagree. It will never replace the Internet search engines, but it does present interesting information that’s well formatted.

Another plus of the site is that the data have been vetted by one of the data curators on Wolfram’s staff. The firm has been building its database for years, thanks to its flagship product, Mathematica, a program that, after 20 years, has become a very powerful computation and data-visualization engine. When you click on “Source Information” at the bottom of each query page, a box pops open that notes that the primary source of financial data is Wolfram Mathematica’s own database. Other sources for financial data include Xignite, Morningstar, BankRate, and our parent company, Dow Jones.

If you enter a ticker or a company name in the query field, you’ll get a delayed quote followed by fundamental data, a price graph, and return comparisons to several competitors, the S&P 500, and Treasury bills. Most of the boxes containing results have drop-down menus that allow you to change the display period or the type of data displayed. For instance, the default for company data is to display fundamentals (market cap, total revenue, number of employees, etc.), but you can change that to select financial ratios or various financial statements.

So—is Wolfram/Alpha worth adding to investors’ and traders’ tool kits? Since it’s free for now, what the heck. (The site is ad-supported, but the ads are not at all invasive.) But it’s less useful if you progress beyond displaying fundamental data or making loan payoff calculations.

Spokesman John Ekizian says, “I know we’ll get a lot bigger and better on financial data as time goes on.” He says that people have been making ample use of the feedback box at the bottom of each page, supplying Wolfram with new ideas. Ekizian says that companies will be able to load their own data privately, for in-house use later on. “We will create professional versions separately and privately in the future,” he says.

Wolfram/Alpha has already turned into a blogosphere group project. People are teaching each other how to use it and correcting each other, sometimes gently, sometimes not. Searching a Twitter feed on “WolframAlpha” generates dozens of posts every minute, many complaining it’s impossible to use; many others saying it’s great.

TECH-INVESTING NEWS, consolidated: Tech Investor News, based north of San Francisco, launched the Tech Investor News Network (http://www.techinvestornews.com) on May 28. We got a look at it just prior to the public launch. TIN previously had several online sites that focused on individual companies, such as Apple Investor News and Google Investor News.

Tech Investor News uses a process called intelligent news search that groups headlines into relevant categories using filters developed and continually updated by human editors. Founder Frank Cioffi says this automated/human system makes TIN’s headline results more accurate than electronic aggregators. The headlines are displayed with the most recent news on top, and each page is automatically refreshed every 15 minutes. You can update the page manually by hitting the Refresh button on your browser; the countdown to the next automatic page update ticks away near the top of the screen.

The summary page collects the news in categories such as Analysts + Commentary, Top Tech Headlines and Blogs + Tech Dialogue. Others include Software, Consumer Tech + Gadgets, Mobile + Wireless and The Internet. If you click on a category heading, you’ll get an entire page of articles on that subject. When you roll your cursor over a headline, a pop-up article preview is displayed, so you can decide whether to click on it and read the entire thing. Clicking on an article headline opens a new window, where you can read the article in its original setting.

The articles that TIN picks up all seem to fit very neatly within their categories, which is extremely helpful for the overloaded news junkie. This site is also ad-supported—however, the ads are quite a bit more obvious than WolframAlpha’s.

TWITTERERS TO FOLLOW: Bob Brinker (twitter.com/bobbrinker) often tweets links to useful articles about banking and debt. He’s also a co-founder of http://www.twitdoc.com, which lets users upload files, like documents or photos, and post a tweet about them in one step. A very helpful service for frequent tweeters. I’ve been following Twitter_Tips (twitter.com/twitter_tips) for a few weeks, and have picked up all kinds of good ideas and advice, such as how to avoid Twitter-phishing scams, and how to attract and retain followers. I’m there, too, at twitter.com/twcarey.

Published in Barron’s, June 1, 2009.