What Works: Getting Started at Trading Foreign Stocks

Of all of the advances online trading has wrought, easy access to foreign stocks is not one of them. And that's not such a bad thing.

Between the numerous exchanges, out-of-sync schedules, currency conversions and liquidity risks -- and the lack of good info on the Web about each of these factors -- buying overseas stocks online is not a wise approach for most people.

But that doesn't leave the overseas U.S. investor without options. Over the next several days I'll detail various ways U.S. investors can tap foreign markets. Today, I'll provide a primer on buying individual stocks, both ADRs -- essentially the U.S.-traded version of foreign stocks -- and stocks that are issued on a local exchange, called "foreign ordinaries."

What Works in Overseas Investing

Coming Up:

Good and Bad Broker Services for Int'l Investing

Funds, ETFs, and Other Ways to Buy Baskets of Overseas Stocks

Best Sites for Foreign Investing Info

Later this week, I'll discuss some of the niche brokers that offer services for placing foreign trades, like Intltrader.com and Globeshare, as well as what you'll find at full-service online brokers, like Schwab and E*Trade. Then I'll provide my take on the more diversified tack of purchasing groups of overseas stocks through vehicles like closed-end funds, exchange-traded funds, and some other new and intriguing approaches.

Finally, I'll review the best sites for getting information on foreign stocks, funds and markets.

Throughout the series, if you agree, disagree, or have anything else to add, please email me at [e-mail] and please include your full name. Also, I've received some choice picks for "unsubscribe watch." If you've encountered email newsletters you just can't extract yourself from, please let me know at [e-mail].

ADR Soup

Have you ever used some terrific product and wanted to buy the stock, only to find it's not listed on a U.S. stock exchange or market, like the New York Stock Exchange or Nasdaq? Think Nestle, Nintendo or maybe Volkswagen.

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Just because the stock isn't listed doesn't mean you can't get it, though. It's just not going to be as simple as punching up CSCO.

The first thing you need to find out is whether the company trades as an ADR, or "American Depositary Receipt." ADRs are securities issued by commercial banks that represent shares in a non-U.S. company. There are about 2,200 ADRs, according to the Bank of New York. Many of the best known ADRs are listed on U.S. exchanges (Finnish mobile phone giant Nokia(NOK Quote), for example, is listed on the New York Stock Exchange). These stocks are just as easy and cheap to trade online as an AT&T or a Microsoft; you just input the U.S. symbol.

Unfortunately, the majority of ADRs are not listed. Rather, many trade "over the counter" through U.S. brokers, so they have both their local symbol and a five-letter symbol for U.S. trading. An example is Swiss food company Nestle, whose five-letter U.S. symbol is NSRGY.

Your broker may let you trade nonlisted ADRs online (I'll specify some brokers that allow you to do this in my next column). However, you'll need to ferret out the symbol for this unlisted security. Thus arises the first reason why I'm not so keen on pure "online" trading for foreign stocks. Some of these companies trade under a variety of symbols, depending on the exact form of the security. To make sure you're trading what you think you're trading, you need to be extra careful. A knowledgeable human being can help.

The Bank of New York site has a list of ADR symbols on this page. There's also a symbol search at www.adr.com. I urge you to use both sources before you trade a nonlisted ADR to make sure you've got the right symbol. If you're in doubt, try to triple check with a broker. Schwab, for example, has a team of "global investing specialists" that can get you the symbol for an unlisted ADR, according to Steven Chandler, VP of global trading.

Foreign Ordinaries

What happens if your company does not have an ADR? If you want to buy individual shares, they've got to be issued in the local markets, say Milan or Australia. These shares are called "foreign ordinaries" or, in the jargon, "ords."

There are two main decisions when trading foreign ordinaries. First, if there is also an ADR, which is the better way to go, the ADR or the ordinary? Second, if you are buying the ordinary, is it better to trade directly through the local market, or through a U.S. market maker?

ADR vs. Ordinary

First question: whether you should buy an ADR vs. an ordinary. The two main factors are liquidity and the price difference, or "spread," between the ADR and the ordinary. The two factors are related, since the more liquid the stock, the better the price you'll generally get.

An unlisted ADR is often not as liquid as an ordinary, so even though the ordinary may cost a bit more to buy because of associated costs (which I detail below), the extra liquidity that would enable you to easily unload the position when the time comes may be worth it. If, however, there is plenty of liquidity in the ADR -- with an NYSE listed one like Nokia, for example -- it's generally better to go that route, since you'll probably get a better price and you avoid the extra costs that come with purchasing ordinaries.

Still uncertain about whether to buy an ADR vs. an ordinary? That's all the more reason why a live person with experience can help in making this decision.

Local vs. U.S. Market Maker

If you decide to buy the ordinary, there's the local vs. U.S. market maker question. If your trade is placed through the local market, that occurs when that market is open. If you purchase your stock through a U.S. market maker, that's a U.S. markets hours trade. The timing matters because the U.S. market maker will tack on a premium for the risk he assumes by trading a stock when its market is closed.

Whether you do the trade through a U.S. market maker or a local exchange (and not every broker will even give you the latter option), you'll face certain costs that wouldn't apply to regular U.S. stocks. These could include the cost of accessing the local market -- someone's got to pay that local agent -- a currency conversion fee, a custody fee for a local institution holding shares and the costs to settle your trade in the U.S.' standard three days, as opposed to what might normally run as long as 10 days in the local market.

How will you know what you're paying for? That brings us to the question of price quotes.

Foreign Quotes

One of the most elusive things about investing in ordinaries is quotes. Foreign ordinaries not only have their own symbols, but they also have five-letter symbols for market makers in this country. For Telecom Italia Mobile SpA, for example, the Milan symbol is TIM while the U.S. identifier is TLEAF.

Pros can get quotes on ordinaries from Reuters or Bloomberg terminals, but such services are more rare online. One place that does provide five-letter quotes is E*Trade's quote lookup under "Quotes & Research," which is open to the Web public. While E*Trade's is a good service, a live broker can get a ticker for you if you can't find one or can help ensure you've found the one you're looking for.

As for price quotes, whether you get the quote online or from a live broker, the quote is not necessarily "firm" -- a quote that a broker can actually deliver in a trade. A firm quote should reflect all those various costs listed above. And even if a broker gives you a firm quote, the price you end up with might not be precisely the same, because of imperfections in the process of measuring all of these factors.

So if you do speak to a broker for a quote, make sure you ask whether that quote is just an indication of where the stock is trading now among U.S. market makers or where it closed on the local exchange, and whether it's a firm quote and, if so, just how firm it is. Consider placing a limit order to protect yourself from any big market swing.

Do You Qualify?

One last twist. Under basic securities regulations, brokers can judge whether an investment is right for you, and they may be more rigorous on this score when it comes to international investments. The brokers that I've spoken with said they don't tend to turn eager investors away (surprise) but they may educate you on the risks involved. No downside in hearing them out!

Coming Up

Later this week, I'll take a look at some brokers who specialize in foreign trading, like Intltrader.com and Globeshare. I'll also touch on the international services offered by full-service online brokers, like Schwab and E*Trade. If you have any overseas trading experience with these or other sites, please let me know at [e-mail].