Net Stock Summit: Could ECNs Be the Final Nail in Old Wall Street's Coffin?

Day traders are using electronic communication networks to make cheaper (and better) trades.
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It's just past 11 a.m. on the

Tradescape

trading floor and Steven Taub is playing the waiting game.

Taub, a 31-year-old

Ithaca College

graduate, is one of about 10 day traders transfixed by their computer screens in a dark, cramped, stuffy room on the 22nd floor of a midtown Manhattan office block. All told, 90 day traders, mostly young white men, are doing the nine-to-five routine at Tradescape, a 1 1/2-year-old discount brokerage firm catering to the growing ranks of day traders.

A few feet away from Taub's terminal, a couple of guys talk the talk in a minikitchen. Scraps of food litter the counter, and the sink is overflowing with dirty coffee cups. "It's like a big frat house," explains one.

This morning, Taub bought 500 shares of

Lam Research

(LRCX) - Get Report

, a manufacturer of semiconductor processing equipment, at 30 1/8. His plan was to get out when the stock hit 30 1/2. Taub was confident that he could bail out at that price because he was placing his order through the

Island

trading system, an electronic communication network, or ECN, that displays and matches

Nasdaq

buy and sell orders. Island, owned by

Datek Online

, is one of several ECN options that Tradescape offers through its proprietary

FirstLevel

trading software.

ECNs are a day trader's fantasy and a nightmare for Wall Street. In contrast to a Nasdaq Level I screen that you'll find through an online brokerage such as

E*Trade

(EGRP)

, ECNs offer Level II information showing the prices and sizes of all the bids and asks on Nasdaq stocks, among other information. ECNs give traders a sense of the relative buying and selling pressure and can help them time an order.

This is the third revolution to hit the brokerage industry in the past 20 years. First, fixed commissions were eliminated in the mid-1970s. Then came the rise of online brokerages in the early 1990s. And now, say day traders, comes the final nail in the coffin of the old Wall Street.

James Marks, an analyst with

Deutsche Bank Securities

, estimates that ECNs now account for as many as 35% of Nasdaq trades, and that figure is sure to keep rising. Naturally, Wall Street's old guard is not happy. Philip Feigin, executive director of the

North American Securities Administrators Association

, compares day trading to gambling.

But for day traders, ECNs are their tools of the trade. "It's very hard to get good prices over the phone with these online brokers," gripes one day trader. "This system allows us to get the best prices and quotes quicker than anyone."

Just after noon, Lam Research started to move, ticking above 30 1/2. But instead of riding out the momentum, Taub was out quickly. His asking price: 30 5/8. Thirty seconds later, someone scooped up his shares. That made him $250 minus the $12 commission.

"You gotta be disciplined," explains Taub, who used to trade for

RAS Securities

. "If you don't have any discipline in this market, you'll be up for a few weeks and then you'll be broke."

The ECN Revolution

"The entire structure of the securities industry is being turned on its head right now," says Omar Amanat, Tradescape's 26-year-old founder and CEO.

After graduating in 1995 from the

University of Pennsylvania's Wharton School

, Amanat traded foreign-exchange derivatives for

Citibank

. A year later, he bailed to help Datek launch its online trading brokerage. But that was a merely a stopover to the big time: putting up his own shingle at 499 Park Ave.

After close to a year, Amanat left Datek and founded Tradescape. To help him build out the new service, Amanat later recruited Datek's head of online trading and one of the company's lead programmers. Today, in addition to the Park Avenue office, Tradescape has 30 traders in a downtown New York office and about 500 more in branch offices in major cities such as Los Angeles, Miami and Denver. And Tradescape has given out a Web-based version of its FirstLevel software to 400 more traders who are unable to make it to a bricks-and-mortar branch.

Next is the public launch of the Web-based product, slated for March 1. This is a watershed moment because it marks the first time that Level II market information will be made available to the public for free. Previously, this information was available through various vendors but only for a high fee. Amanat hopes that Tradescape will sign up 10,000 customers by the end of the year.

"I don't think the fearmongering of the wire houses makes any sense," says James Lee, chairman of the

Electronic Traders Association

and founder of his own Houston-based day-trading firm,

Momentum Securities

. "They're always looking for a scapegoat when they feel the pressure on their underlying business. They're worried about loss of order flow, loss of margin lending and loss of market share."

However, Lee is careful to draw a distinction between investing and trading. "Nobody is saying that trading is investing," says Lee. "People have always traded for a living."

Take 23-year-old Kirk Kazazian. An economics major from Penn who says all he plays is Net stocks, he is averaging a 5% to 10% daily return on a $500,000 daily account. Kazazian estimates that two-thirds of the people at Tradescape attended Ivy League schools, and half of them have professional trading experience gained through Wall Street firms, hedge funds or market makers.

Kazazian tracks the Nasdaq for the day's movers, usually going with seven or eight different stocks. He likes all the usual suspects, including

Yahoo!

(YHOO)

,

Lycos

(LCOS)

and

Books-a-Million

. Fundamental research? He doesn't have time. Instead, he hunts for news and technical data, monitoring buying and selling patterns.

Kazazian may be the future. That's because white-shoe Wall Street firms are also chasing day traders. At the moment,

Instinet

, a unit of

Reuters

(RTRSY)

, is the largest ECN with 69% of the market. But the field is getting crowded. Recently,

Morgan Stanley Dean Witter

(MWD)

and

Goldman Sachs

bought equity stakes in two other ECNs --

Archipelago

and the new

BRUT

system. Similarly,

Salomon Smith Barney

and

Donaldson Lufkin & Jenrette

(DLJ)

took equity stakes in another new ECN called

STRIKE

.

"I really believe we're all targets," says Momentum's Lee. "I don't think we can internally build the critical mass to properly use these high-end order execution systems that we've developed. We've taken a good step, but to really get scale, the big guys are going to have to come in."

And that day may not be that far away.

The impact of day traders on Net stocks and the Nasdaq will be one of the topics of discussion at the

TSC Net Stocks '99 Summit on Friday, Feb. 19, at 5 p.m. EST.

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