Online Brokers: 'Buy'em When They Feel the Worst'

NEW YORK ( TheStreet) -- Online brokers may have seen a dip in trading volumes during August, but retail trading likely outpaced institutional volumes for the second consecutive month, according to Sandler O'Neill & Partners.

Based on so-called channel checks conducted by Sandler analyst Rich Repetto, daily average revenue trades (DARTs) at the three largest online brokers, TD Ameritrade ( AMTD), E*Trade Financial ( ETFC) and Charles Schwab ( SCHW ), fell 5% in August, he writes in a research note. Repetto notes, however, the decline could be plus or minus 2.5%.

E*Trade's daily average trades declined the most since last year, down 36.2% to 122,700, the note estimates. The other two online brokers also had double-digit declines from the year-earlier periods when markets were experiencing broad rebound and heavy trading among high-volatility stocks , such as financials.

The brokers are expected to release their latest monthly DART metrics in mid-September.

However, consolidated tape volume - which are trades across the New York Stock Exchange as well as NYSE Euronext's ( NYX) smaller exchanges -- dropped roughly 12.6% in August. It is the second straight month in which retail trading outperformed the institutional side, according to the note.

Average daily dollar volume declined 12.9% to $141.7 billion.

Repetto noted that 10 of the 12 slowest trading days this year were in August and the other two in July.

"We suspect that one potential cause is less buy side activity from institutional firms that are experiencing consistent outflows (16 straight weeks) from their domestic equity mutual funds," Repetto writes.

The slowdown in trading can be seen in two of the most actively traded stocks - Citigroup ( C) and Bank of America ( BAC).

Citi's three-month average volume is now at 506 million, for example, with roughly 310 million shares traded by 2 pm ET on Wednesday. That compares to the upwards of 1 billion shares traded daily seen in Citi's stock on several days in the second quarter.

The combination of lower volatility, record low short-term interest rates and general seasonal slowdown in the summer months is proving to be a nuisance for the online brokers, since they garner a significant portion of their revenue from DARTs.

Both Schwab and TD Ameritrade hit 52-week-lows on Tuesday. The shares are down 26% and 32%, respectively since the May 5 flash crash. E*Trade shares are down 25% since May 5, Repetto says.

That being said, Repetto writes that while "the long-term buy-and-hold retail investors could stay away from the equity market for an extended period of time given the economic recession and issues with market credibility (i.e. flash crash), still it's the active trader that drives the vast majority of trading" at the online brokers and primarily driven the DART outperformance vs. total industry volumes.

"We believe the common phrase 'Buy'em When They Feel the Worst' could very well apply as we move through the summer trading doldrums of August and post the flash crash," he writes. Repetto has buy ratings on all three of the largest online brokers.

On the other hand, futures volumes continued to show strength in August.

CME Group's ( CME) daily contracts averaged 11.7 million, up 8.2% sequentially and 15% year-over-year, the note says.

The IntercontinentalExchange's ( ICE) future contracts rose 3.9% sequentially and 18.4% to an average of 1.2 million contracts, Repetto calculates.

Options volumes followed equities, declining somewhat in August, the note says.

Along with the broader markets, E*Trade shares were most recently surging 4.8% to $12.99. Schwab shares were surging 5.8% to $13.50, while TD Ameritrade's stock was up 2% to $14.92.

--Written by Laurie Kulikowski in New York.

To contact the writer of this article, click here: Laurie Kulikowski.

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Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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