Investing: e is for easy

By Bob Weinstein, Globe Correspondent, 02/11/99

How on-line trading works In keeping with Securities and Exchange Commission regulations, you must have money on deposit in an account with an online broker before you can start trading. Once a trade is executed, you're required to pay for the stock within three business days following the transaction. The amount you deposit varies from firm to firm, according to David Ellis, professor of finance at Babson College in Wellesley and former institutional trader at brokerage house Solomon Brothers Inc. ''The most common amount is $2,000,'' he says. ''The amount can vary from $1,000 to $10,000.'' It will probably take seven or eight days to set up an account. Forget about using credit cards, because it is illegal to purchase of securities (of any kind) with a credit card. There are various proposals in the works to speed up the process, says Ellis. ''In the future, banks and credit card companies may allow you to transfer cash over the Net,'' he says. ''But, it could take a couple of years before the details are worked out.'' Some online brokers, Datek On line and E*Trade, for example, allow consumer to open accounts online. However, most require a traditional written application. But, all firms allow you to request an application online, which can save you the frustration of a telephone call. What does a bigger deposit get you? ''Typically, more products and services,'' says Ellis. ''Rather than just buying stock, you can also buy mutual funds, options and bonds and take advantage of free research, which is usually not available at the online traders requiring small deposits.'' Once, your check clears and your account information is in the online trader's computer, you're given a password, which allows you to trade and receive confirmations within 10 to 20 seconds of a trade. Once a trade is confirmed, you're online portfolio is immediately updated.

Geneva Woodruff of Brookline and John McLain of Keene, N.H. have a lot in common. In the last year, they both began dabbling in online trading and enjoying every minute of it.

Woodruff is the director of the National Center for Young Children At Risk & Their Families in Acton and McLain heads McLain Communications, a national media placement company.

While Woodruff still has most of her stock holdings with old-line mainline brokerage house Merrill Lynch, she says she always wanted to trade online. At a friend's suggestion, she turned to Datek Online, an online brokerage firm that charges $9.99 per transaction up to 5,000 shares.

Woodruff says she had received a ''hot tip,'' and after researching the stock online, she executed the transaction immediately. ''I loved it,'' she says. ''It felt like an adventure because I was flexing my financial muscle without using a broker.''

Woodruff says she'd do it again, yet she is remains cautious and will always fall back on a traditional full-service broker for the bulk of her trades. ''Until I learn a hell of a lot more about online trading, I'd never build a significant amount of my portfolio through this method,'' she says.

Not so with McLain. He dropped his traditional broker a year ago after concluding he was giving up too much profit on brokerage commissions. ''Aside from spending more than I should, I was getting second-class service because I was a small trader,'' he says. So McLain took his investment fate in his own hands and started trading on line. But unlike Woodruff, who did it as a lark, McLain did so with a passion. He researched the process by reading four books on on-line trading.

Then he checked out the brokers and decided on E*Trade because it was one of the pioneers in the field and offered an easy-to-navigate site with good tutorials. He felt the $14.95 per trade fee (for up to 5,000 shares) was a good deal. ''I like on-line trading because I enjoy running my own show,'' he says, ''and you can't beat the price.''

According to Forrester Research, a Cambridge consulting firm that focuses on technology, about 3.4 million Americans have active on-line stock-trading accounts and are saving hundreds of millions of dollars in commissions by using them.

Thanks to computerization of the brokerage industry, on-line trading has become a booming industry, says David Ellis, professor of finance at Babson College in Wellesley and former institutional trader at brokerage house Solomon Brothers Inc. It all happened within the last three years.

''It's amazing when you consider that on-line trading wouldn't have happened if it weren't for the sophistication of the Internet,'' says Ellis. ''Now 90 percent of all trades are transacted via computers.''

TRADING OR GAMBLING? It's easy to get sucked into the on-line trading drama with the idea of making a quick killing. Just as compulsive gamblers can't stay away from casinos, the adrenaline rush that comes from a quick profit is attracting what Jeremy J. Siegel, a professor of finance at the Wharton School of the University of Pennsylvania, calls an ''on-line gambler.'' ''The tremendous reduction in the cost of trading along with the small spreads between bid and asked prices have attracted a group of investors who think they can make fast money,'' he says. ''Of course, they only see one part of the equation. They don't ever consider that it is also easy to lose money quickly. They figure it is just as good or better than hitting the casinos.'' Without even realizing that it is happening, some people are going to be hooked, says Siegel. ''The result is enormous problems and angst, especially if you're squandering hard-earned retirement savings,'' he adds.

And many of the on-line brokers are not going to go away, according to Ellis. ''So far on-line trading companies have stood their ground, even when the market dipped sharply in July and September,'' he says. ''Because it's a new industry, we can expect a shake-out over the next five years. Some companies will disappear, others will be absorbed by some of the large full-service brokers.''

For the most part, Ellis says on-line investors are investing in the same stocks and bonds traditional investors are buying. The big difference is simplicity and speed in executing transactions. ''All the middle people have been removed from the transaction,'' he says. ''In the past, every transaction went through about four people. On-line trading has made investing easy, fast and inexpensive. While a full-service broker might charge $100 for buying 200 shares of a stock, for example, an on-line broker charges only about $20. You type in a trade and it goes right to the market maker and the transaction is executed. It's truly one-stop shopping.''

On-line trading has become so popular, the American Association of Individual Investors has created a separate category for them so on-line stocke traders can be tracked and monitored.

Cheap trades are a hallmark of on-line brokerage transactions, and since 1996, the cost of the average on-line trade has gone from about $30 to less than $15. The cost is likely to continue to fall, according to Forrester analyst Michael Gazala.

Price cuts, says Gazala, have been driven by competition as more companies get into the on-line stock-trading business. In 1995, 12 companies offered on-line trading. In 1996, the number rose to 33. By late 1997, the number was closer to about 100, according to AAII.

Meanwhile, on-line investors, as a group, have changed dramatically over the last few years. ''In 1996 and 1997 on-line investors were considered outlaws,'' says Gazala. ''Today, they represent average investors.''

Jupiter Communications, a New York City-based research company that tracks new media projects, estimates that by 2002 there will be 15.2 million investors doing on-line trading.

So who are these ''average investors?'' According to Forrester Research, more than half of on-line investors are under 40 with a median household income of $78,000. Thirty-four percent have more than a quarter of a million dollars in investable assets. Moreover, 71 percent have finished at least four years of college. Gazala refers to this group as the ''on-line elite.''

Among the on-line trading pool, Ellis estimates that 20 percent are outright speculators who are taking advantage of the bull market by aggressively wheeling and dealing all day long. They're called day traders because in the space of a day, they'll execute as many as 80 trades and by the closing bell they'll have closed out all their positions. ''They're a class unto themselves,'' says Ellis, who adds this kind of frenetic trading is not recommended for those who don't have the temperament - and pocketbook - for rapid-fire trades.

''Be as prudent with on-line investing as you would with any other type of investing,'' he says. ''Don't take unnecessary risks, especially if you're on a roll.''

Robert Neal, associate professor of finance at Indiana University's Kelley School of Business, offers two warnings about on-line trading. First, ''don't think you're smarter than you really are,'' he says. ''With all the financial information and analytical reports available, it's easy to think you can beat the market. In reality, it's getting harder. Last year, more than 90 percent of mutual funds returned less than the benchmark S&P 500 index.''

And second, ''don't trade too often,'' says Neal. ''Investors with on-line accounts are more likely to buy and sell stocks than investors with traditional brokers. This is important not only because of the commissions paid on each trade, but also because trading tends to reduce your overall return. Studies have shown that investors who trade actively do worse than investors who trade infrequently.''

James Angel, associate professor of finance at Georgetown University's McDonough School of Business, agrees. ''Studies have proven that the more you Continued on next page trade, the more you tend to lose,'' he says. ''Just because you can do it yourself doesn't mean you should be trading all that much. If you have the same information everyone else has, chances are you're going to get the same results.''

He adds, ''It's easy to be seduced by a bull market. This market has lulled many investors into thinking they are stock market geniuses, when in reality they just got lucky.''

If you think on-line trading is big now, just wait. By the time the millennium clicks into place, it's estimated 10 million brokerage accounts will be trading on the Internet, nearly twice the number now. And the big guys, the full service brokerage houses like Merrill Lynch and Prudential Securities, will be offering on-line trading services as well, Gazala predicts.

''They're getting ready and testing it now,'' he says. ''It's all a question of methodology and what their role will be. They don't want to be discount brokers.''

Bob Weinstein is a New York-based writer and is a frequent contributor to The Globe.