Casey Higgins, MIS 571

Casey Higgins, MIS 571

Journal Article Review, December 5, 2008

Online Brokerages

Article 1: Barron’s Online, November 15, 2008, by Theresa W. Carey

Making It Click: Annual Ranking of the Best Online Brokers

This article is an up-to-date review of the best online brokers from a finance-centric, as opposed to technology-centric, perspective. The Barron’s publication is geared toward professional investors but is also accessible to laymen, and so the article is useful to shed light on the practical consumer issues related to online brokerages, such as usability and customer service. 23 leading online brokerages are assigned scores on eight different metrics (trade experience, trade technology, usability, range of offerings, research amenities, portfolio analysis & reports, customer service & access, and costs) and ranked by total score to determine the best websites. Assuming these eight metrics represent an accurate reflection of educated investors’ priorities and values, as judged by a credible source, it follows that any online broker would serve to benefit from adopting these criteria as their own business objectives and metrics.

From a usability perspective, some of the best sites incorporate Javascript and AJAX to provide the same functionality as a local software application, such as streaming data, context-based research, customization by user preferences, and fast navigation between pages. From a customer service perspective, top priorities for investors today include live chat, online research and education, as well as mobile account access. A testament to the improved technology of web-based brokerages compared to direct access platforms is that, while Barron’s used to differentiate between these two categories, in 2008 the entire competitive field was ranked together based on the same metrics. Some unique challenges of online brokerages include the need to aggregate live pricing data from disparate global markets, for an increasingly complex array of derivative instruments, while also sifting through sources of transaction data in order to present actionable insights to the investor in real-time. While the electronic routing and execution of orders through the global financial markets presents technological hurdles alone, adding the online interface to input orders and output executions introduces another layer of complexity.

Important considerations for investors include powerful yet user-friendly screens to help choose which securities to trade, the ability to place trades in multiple ways, such as from a graph, as well as sophisticated tools for analysis, charting, and back-testing. For example, portfolio reports should be clearly laid-out and updated in real-time, they should present extensive transaction history with tax reporting, should link to news, research, and charts for portfolio holdings, should track real-time quotes, order entry and execution progress from any page on the site, and there should be third-party research integrated into the site. There is virtually no gap today between the range of investments that can be traded online versus offline, with the best online brokers offering the largest number of stocks that can be sold short, as well as the widest variety of options, funds, bonds, commodities, futures, and international securities.Costs are also an important factor, mostly in terms of commissions, maintenance fees, and margin rates, although this year’s winner, TradeStation, charges $99.95 per month for its trading platform with a deep historical database for back-testing, which goes to show that while customers pay expect certain costs to be virtually zero (i.e. commissions), they are willing to pay for other costs if the service offered is truly valuable. The second-place winner, ThinkorSwim, stood out for its sophisticated Java-based platform, which offers several methods of trading from different areas of the site, as well as stellar customer service and education. It’s telling that the three online brokers owned by banks finished in the bottom of the pack, mostly for their limited offerings and poor technology, which suggests that the best should focus on the brokerage business as their core competency.

Since the author represents Barron’s, a magazine for professional investors, her point of view is geared toward the customers of brokerage websites as opposed to the brokerages themselves or a third party such as the brokerage regulators, and, within the customer demographic, it is further geared toward the experienced trader rather than the novice investor. As such, the rating system assumes that the average customer trades frequently, maintains a sizable amount of assets with the broker, invests in alternative securities such as options and futures, and requires sophisticated tools for technical analysis. However, the review scores may be less useful for customers who trade less frequently, maintain a small amount of assets, invest in only traditional securities, and don’t require sophisticated analysis tools. In addition, since Barron’s is a commercial publication and not an academic, peer-reviewed journal, there is the potential for bias if Barron’s publishes what they think will be popular with readers, or if the freelance author want to ensure future paid articles with Barron’s, or if the magazine has advertising contracts with any of the brokers.

This article is important because it presents a user-centric perspective on online brokers “in plain English”, which is a good introduction to the key issues before delving into the more technical articles backed by research studies and validated by evidence. However, as mentioned previously, its biases are notable and its scoring system is somewhat arbitrary, so while it contains useful information for the individual investor on the various considerations to make when evaluating online brokers and the relative strengths and weaknesses of the leading websites, the scores themselves shouldn’t be taken at face value, nor should the declaration of the “winners.” The author does state that different readers will have different priorities, but that the sub-scores on the eight metrics can be used to identify a personal “winner”; for example, if, like myself, the investor is focused on minimal costs, they can choose a broker with the highest sub-score for that metric; however, substantial trading activity is still assumed (lowest per-share commissions, but a monthly floor in dollars). The winner that was identified by the article, TradeStation, with its $99.95 monthly fee for its trading platform, would be best suited for institutional investors or professional day traders. Since the strength of this platform was the main reason for TradeStation’s victory, it would be helpful if the author went into greater depth on the features of the technology itself, which would not only inform the reader but serve to justify why the broker in fact deserved the win over the second-place broker, ThinkorSwim, which is also lauded for its Java-based interface yet has better customer service. Instead of presenting short paragraphs on about 20 brokers, the article would be more informative if it went into greater detail on a shorter list of brokers (maybe the best for each of the metrics).

Overall, this article demonstrates the powerful capabilities of the online brokerage technology and the real-world benefits of this technology for investors in the digital era. As evoked by the E*Trade commercial showing a family in Southeast Asia buying a stock online, brokerage websites allow anyone with Internet access to be an investor – for better or worse. While online investing empowers the individual, education is the key to responsible investing for all.

Article 2: Communications of the ACM, July 2004, Troy Strader and Sridhar Ramaswami

Investor Perceptions of Traditional and Online Channels

This article attempted to determine individual investor perceptions of the traditional versus online brokerage channels on ten metrics of importance to consumers. Investors were asked which channel was better for each of the ten metrics, measured on a seven-point scale (i.e. 4 = no difference, whereas 1 or 7 = one channel much better). The results were compiled for the overall population, and also for the two sub-populations of online users versus non-users, hypothesizing that the former would favor the online channel whereas the latter would favor the traditional channel. The authors decided on the ten metrics – 1) reduced cost of transactions; 2) convenience; 3) opportunity for taking personal control; 4) ease of conducting transactions; 5) increased rate of return; 6) investment education; 7) trustworthiness; 8) access to information of value; 9) meet personal financial goals; and 10) manage risk level – by reviewing secondary research and conducting investor interviews.

The results of the study could prove useful for both online and traditional brokerages by shedding light on how to market their value proposition for converting new customers and retaining existing customers. For example, based on the findings that the overall investor population perceives the online channel better on the metrics of cost, convenience, and control, this validates the existing strategy of online brokers to differentiate themselves on these features. In addition, based on the findings that the overall investor population perceives no difference between the two channels on the metrics of increased return, investment education, access to information, and lower risk, traditional brokers may benefit from seeking to add customer value by developing these qualities as selling points.Interestingly, the overall investor population didn’t perceive the traditional channel as better on any of the ten metrics (online was better on four, while the other six showed “no difference”); however, non-users of the online channel rated the traditional channel better on eight of the ten metrics. This can be explained in part by cognitive dissonance theory – i.e., the preferences we indicate tend to support our decisions. This theory can also be used to explain the phenomenon of online users rating the online channel better on the same four metrics in addition to the “increased rate of return” metric, even though the data suggests that online returns are about two percentage points lower than returns at traditional brokers, because online users want to believe that increased control will lead to better returns. This sheds light on one of the biggest selling points of online brokers to the individual: the idea that increased control over one’s one investments will lead to better returns.

The study also found that more than 40% of respondents used the online channel for investing (and this was back in 2001-02), which of course has increased since that time, although there will always be a market for traditional brokers among investors who value face-to-face attention and hand-holding when it comes to managing their money. The numbers were somewhat confusing in that the perceptions of the overall sample seemed to reflect those of the online user group (i.e. online channel better for 4 or 5 metrics), although the online user group represented only 40% of the sample, so it’s unclear how the calculations were obtained. In addition, the influence of cognitive dissonance on the survey respondents’ perceptions appears to have had a significant impact on the overall results, so much that it is unclear whether the results should be trusted at all. The fact that the investors were asked to rank their perceptions on a subjective scale may have encouraged this cognitive dissonance bias, and the survey accuracy may have been improved if the investors were asked to provide objective examples to support their perceptions. It also would have helped if the sample size were larger and more diverse; there were only 112 participants, all of which lived in Iowa and were obtained from a single mailing list vendor.

It can be inferred from the nature of the ten investor priorities that the sample consisted mostly of individuals and casual investors, as opposed to the Barron’s readership, which is mostly institutions and professional investors. Consequently, there was little overlap between the two sets of metrics, although this can be explained in part by the fact that the Barron’s study was a comparison of online brokers whereas the ACM study measured qualities of the channel as a whole. It’s notable that relationship attributes such as trustworthiness and longevity, as well as the potential for a broker to facilitate increased returns while managing risk, are priorities for the individuals in the 2001-02 study while absent from the metrics of institutions in the 2008 article. Perhaps either the passing of time or the more educated audience resulted in a loss of any delusions that a broker (traditional or online) could be relied on for trust or return potential.While both articles identify ease of use as a valued metric, the ACM article focuses only on the ease of placing transactions online compared to with a traditional broker, whereas the Barron’s article expands usability to include ease of navigation, user-friendly design, and the ability to place trades from multiple areas.

Since the article appeared in a scholarly journal, the authors’ point of view is more impartial than in the Barron’s article, with the study attempting to shed light both on the consumer perspective and on the take-aways for brokerage firms. While in theory the research design should be reviewed to minimize any inherent flaws such as selection bias, insufficient sample size, and poorly controlled variables, I was unimpressed with the impact of cognitive dissonance that seemed to account for most, if not all, of the statistical significance. I would have liked to see the mathbehind how the online users could be a minority in the sample yet cause the overall results to reflect their perceptions. The study did contain certain nuggets of wisdom, such as the untapped potential for traditional brokers to craft their value proposition based on the ability of financial experts to address investors’ priorities of increased return with lower risk. Judging from the competitive landscape today, with online brokers gaining ground against traditional brokers, and the bank-owned brokers falling to the bottom of Barron’s 2008 review, this value proposition was either never articulated or was poorly received by investors.

The fact that website technology itself was not seen as a differentiator in the early years of online brokerages suggests that the industry has come a long way, and that the initial novelty of lower costs and convenience needed to be replaced by a superior value proposition as the landscape became more crowded and web technologies matured. Risk aversion was included on only the ACM article’s list of priorities, although the fact that the traditional channel was rated no better than the online channel on this metric suggest that, even back then, investors were skeptical of financial experts’ ability to shield them from the market. The range of product offerings offered wasn’t mentioned in the ACM study because it was inconceivable that complex derivative structures could be traded without the help of a broker. The fact that technology-enabled portfolio analysis and reports were omitted from the 2001-02 study while serving as the primary differentiator in Barron’s 2008 study suggests that online brokers today recognize that investors require sophisticated systems for back-testing and charting and, despite the expectation of negligible commission costs, are willing to pay for these Javascript- and AJAX-enabled features.

Article 3: ACM SE ’06, March 10-12, 2006, Alexander Y. Yap

Evolution of Online Financial Trading Systems: Assessing Critical End-User Requirements

This article compared three leading online brokers on four end-user requirements that were identified at the time of the study (2004-05) as critical for a trading system to possess. The three online brokers reviewed were Interactive Brokers, Ameritrade, and Scottrade, and were identified because they seemed to offer a good balance of value with system features. The four end-user requirements measured in the study were 1) order process flow – whether orders are “internalized” (filled within the broker’s own network, resulting in fewer competing bids) or whether they are sent out to the open market to get the best price); 2) targeting niche markets – whether online brokers employ different system features for different types of investors (i.e. Buy and Hold versus Swing Traders), either by one broker specializing on one niche or marketing different features based on the investor type; 3) SEC regulations – whether the system automatically screens orders to prevent violation of SEC trading rules, such as those that prohibit naked shorting (shorting a stock that the broker doesn’t own) and those that require daytrading accounts to have a minimum equity of $25,000, or whether these rules are allowed to be violated; and 4) system integrity – whether online brokers have redundant systems to ensure that trades can still be placed reliably in the event of system failure, or whether they fall victim to downtime that leads to investors losing money. It isn’t clear how the four end-user requirements were identified, besides suggesting that low costs and basic research are no longer differentiating factors since most online brokers provide these features.