Broker Competition Paying Dividends for Active Traders

Online brokers that cater to active traders continue to search for a business model that'll win customers. Thanks to their efforts, traders can now get everything from free software to free computers and free access to private networks, not to mention low-cost trades. With so many competing service plans out there, deciding on a broker is about as tough as choosing a cellular provider.

In fact, the analogy between brokers and cellular providers is a pretty good one, come to think of it. When you sign up with a cellular provider and start giving out your number to people, you're likely to stay with that provider no matter what. Same goes for online brokers. Once you open an account and get to know how the trading software operates, chances are you'll stay put. Brokers and cellular providers know this, of course. So they'll dangle some pretty tempting offers in order to get you to switch, starting with low fees.

Last week, for example two of the largest brokers serving active traders CyBerCorp.com and Tradecast announced price cuts. CyBerCorp.com reduced its execution fees from $19.75 to $17.95 if you make as little as one trade per month. Make 500 trades per month and the fee goes down to $9.95. OK, that doesn't sound like such a big deal. But last February, before the company was acquired by Charles Schwab (SCH Quote - Cramer on SCH - Stock Picks), it was charging roughly $30 per trade. Last week's fee reduction applies to CyBerCorp.com's high-end trading platform, CyBerTrader, which I wrote about in a previous column.

The Leasing Model

CyBerCorp.com doesn't charge monthly rental fees for its CyBerTrader software. But many of its competitors still do, including Tradecast. A day after CyBerCorp.com announced its price cuts, Tradecast cut its monthly rental fees for its high-end Elite execution platform from $180 to $99. (That fee is waived if you maintain a minimum of $10,000 in your trading account.) Tradecast charges $20 per trade, and like CyBerCorp.com, the company offers quantity discounts.

The practice of leasing out trading software goes back several years. In the early days of online daytrading, software was licensed out to trading rooms. Each company put its own branding on the software. Daytraders who frequented these rooms often paid out $300 per month in software rental and exchange fees, though frequently those fees were waived after a trader executed, say, 50 commissionable trades per month. The going price back then was between $20-$30 per trade.

With commissions like that, you'd think trading rooms would be rolling in money. But the constant need to upgrade technology and the constant washing out of clients keep margins low. Which is to say, the trading-room business model doesn't exactly have legs. As a result, Tradecast and CyBerCorp.com were among the first trading-software developers that opened their own online brokerages. By doing so they succeeded in marketing their software directly to active traders working at home.

The World at the Click of a Mouse

Both CyBerCorp.com and Tradecast could get a run for their money from InteractiveBrokers.com. The upstart brokerage affiliated with the market-making/proprietary trading firm The Timber Hill Group made its debut in 1998. The company provides customers with a streamlined, real-time execution platform called Trader Workstation. The platform doesn't come with the many customization options you'll find on CyBerTrader or Tradecast's Elite platform. But Teresa Lo, an S&P futures trader who heads up the chat room site, The Intelligent Speculator, prefers it to other trading software she's used. "It's for a unique kind of client," she says. Read: a sophisticated trader who doesn't require a lot of handholding. "Their interface is very professional. It doesn't look like the inside of a spaceship. It just gives you the information you need."

InteractiveBrokers.com's commissions of a penny per share are about as low as you'll find in the industry. For options traders the deal is even better: $1.95 per contract. And for that, you get direct access to electronic communication networks, or ECNs, as well as futures and options exchanges. In all, you can trade on 38 exchanges and ECNs in 17 countries.

Better than Direct Access

No competitor will likely bring the commission structure much lower and still make money. But one broker, Velocity Trade has devised a very different idea with its Floorpass package. Floorpass lets you trade via a private network. That is, you circumvent the Internet entirely and link up directly to the exchange via a dedicated phone line. It's the same as if you were dialing up America Online (AOL Quote - Cramer on AOL - Stock Picks). With the private network, you won't have to worry about Internet backlogs or pray that your Internet service provider doesn't go down.

The Floorpass package also includes a computer preloaded with software, plus two 15-inch, flat-screen monitors. You receive a real-time data feed from eSignal and an audio link (called a squawk box) to the exchange floor. The latter lets you hear the actual bidding. Commissions run $19.95. You have to pay for a dedicated phone line (maybe $25 per month in most areas) in order to link with the private network. That network is available in 150 cities nationwide.

The great advantage of trading via a dedicated termina, at least theoretically, is that all the software has been professionally installed and tested. This greatly minimizes the chance of software conflicts (maybe from that screen-saver you downloaded) causing a system crash when you're midway through a trade.

So far, Floorpass is only set up to trade index futures, both regular-sized and e-minis (one-fifth the size of a standard futures contract). Index futures are futures contracts on popular stock indices such as the S&P 500. The Floorpass network routes regular futures orders direct to the pits of the Chicago Mercantile Exchange and other global futures exchanges. Once there, actual execution may take place via an open outcry system, which can result in time delays and slippage. For this reason, traders like Lo prefer e-minis on the S&P and the Nasdaq. Both trade on a direct matching network called Globex2, which is administered by the CME. A direct matching system gives you a better shot at execution if the market is moving rapidly.

Watch This Space

Will traders rush to sign on with Floorpass? Probably not at first. That's because the great majority of traders would rather trade stocks -- because they're familiar with them -- then the riskier futures contracts, where your losses can exceed the amount you invest. Floorpass officials are considering adding securities and options. And you can bet if their business model is successful, others will be offering free computers and private network linkups as well.

In hindsight, you have to wonder why it's taken so long for an online broker to come up with a package like Floorpass. After all, Internet service providers have been luring customers with free computers and $400 rebates for well over a year now. And if they can make the numbers work based on $25 per month Internet connection fees, brokers charging $20 per trade should be able to turn a profit.

Let's hope so, anyway. Because a direct link to a broker is the ultimate trader tool. Floorpass claims its customers' orders can reach the exchange in less than 0.02 seconds. Institutional traders have long traded using private networks provided by the likes of Reuters, Bloomberg and Bridge. Now that edge may finally be coming to active traders. And it could mark a whole new stage in the online trader revolution.