Saturday, June 25, 2005

Day Trading has Dried Up

Financial Post, Barbara Shecter, 25 June 2005

The day trader is dead. And his cousin, the active trader, is ailing. Certainly, the tales of quick trading profits in the thousands and even hundreds of thousands of dollars are no longer the centre of attention at parties; guests are more likely to be discussing their latest real estate gains or renovation projects.

Alan Fern, a philosophy major who left the University of Saskatchewan in the spring of 2000 for the bright lights of New York and a job as a day trader, hung up his keyboard 1 1/2 years later, along with legions of his former co-workers who watched the dot-com bubble burst.

He compares his early days at Broadway Trading Inc. to life in a college dorm -- but with the added benefit of making a lot of money during the dot-com trading frenzy in the 1990s. But by late 2001, stocks were no longer routinely rocketing up, sometimes $30 in a single day. In addition, the conversion to trading shares in decimal increments instead of fractions erased the spreads between the bid and asking prices for stocks on which many day traders depended for profit.

"Guys who were making a lot of money just the year before were losing tons of money," says the 35-year-old Mr. Fern. "There was a palpable fear. People either ran out of breath or got frustrated and fell off."

The precipitous decline in trading activity marked the beginning of a disturbing trend for the discount brokerage industry.

That, plus the lacklustre performance of stock markets, have pushed day traders and their active trading cousins, who didn't trade daily but did trade often enough to keep discount brokers happy, to the sidelines.

As a result, firms that once relied on the commissions generated by the frequent trades have been forced to shift focus dramatically to a new component of the market: wealth management.

Nowhere is that made clearer than in this week's US$9-billion merger of TD Waterhouse USA and Ameritrade Holdings Corp. Long-term growth for the new TD Ameritrade lies in development of the wealth-management segment, which provides a steadier income stream and gathers assets for long-term management, mitigating the reliance on the one-off trade commissions.

No one is more familiar with the dulled appetite of the active trader than Joe Moglia, the dynamic chief executive of Ameritrade, which was built in the bull market when it was hard to buy stock that wasn't going up daily.

"The day trader has, for the most part, blown up," Mr. Moglia said. "That business is gone."

But a more disturbing blow to firms relying on commissions generated from active trading is more investor are now thinking long term, Mr. Moglia said. Also, according to his research, traders are keeping an unusually large 15% of holdings in cash because of concerns about the price of oil, the direction of interest rates and the overall state of the economy.

"They're either on the sidelines or they're bears," Mr. Moglia said. "They like real estate better than stocks."

Where day traders once did as many as 400 transactions a day through Ameritrade, the company's most active traders might now do that in a year. On average, an Ameritrade investor now makes a measly 12 trades a year.

At TD Waterhouse, total trades averaged 93,500 a day in April, down 16% from March and off 26% from April, 2004.

Discount brokers including TD Waterhouse, Charles Schwab Corp., and Bank of Montreal's Harrisdirect have reacted to plummeting trading volumes with a series of margin-sapping price wars as they tried to hold on to market share.

But something more had to be done. From top players in the industry such as Ameritrade, to the second-tier players such as Harrisdirect, discount brokers have focussed on how best to recast the business to recapture the profitability of the early days.

One obvious answer is a merger, which allows combined companies to spread the fixed costs of administration across more trades.

This week's planned combination of TD Waterhouse and Ameritrade will create the largest online retail broker measured by the number of retail equity trades per day. As well, the deal promises more than US$370-million in cost savings.

But Mr. Moglia is unabashed in proclaiming another reason for the merger: his hunger for the substantial wealth-management component of TD Waterhouse from which he sees significant growth.

"It immediately put[s] us into the segment where the long-term investor exists and it makes us a player in the investment advisor market," Mr. Moglia told analysts on a conference call this week.

To hear Mr. Moglia tell it, wealth-management clients are to today's discount brokers what day traders were in the 1990s.

"There are 37 million households in the U.S. with income of between US$100,000 and US$1-million," says the former football coach who joined Omaha, Neb.-based Ameritrade at the height of the bust in 2001. "That's a US$12-trillion opportunity."

His mission originally was to boost the company's fortunes through a series of acquisitions of active trader businesses to cut costs and boost margins. Now he's looking to break out of that finite game, something TD Waterhouse was already on track to do.

"The active trader space has a fixed number of people who will be in it," Mr. Clark said. "It'll go up or down depending on the froth of the market, but it's not going to grow any faster than the population."

Wealth management, on the other hand, provides "an above-average growth space" because of the bulge of ageing Baby Boomers headed for retirement, he said.

TD Waterhouse has been targeting wealthy investors who aren't wealthy enough for the full-service brokers. This group has more than $500,000 but less than $1-million to invest. Investors who want a little advice before investing in stocks and bonds online can get it from one of about 2,600 financial advisors in more than 140 retail branches across the United States.

The bigger plan is to offer levels of service at different price points: from simple online portfolio management and asset allocation tools to full investment advice (albeit without the tax and estate planning).

TD Waterhouse has also drawn in independent financial advisors who left big firms to strike out on their own, offering them access to the discount brokerage's trading facilities and back office. The company has built up US$38-billion in assets through this business, while Ameritrade's fledgling wealth-management business has just US$4.1 billion in assets attached to registered advisors.

TD Waterhouse set the stage in the late 1990s to extend its expertise in wealth management to its discount broker, aided by some key acquisitions that boosted branches and advisors.

Others have jumped aboard more recently, in an attempt to improve their fortunes.

Harrisdirect, which is about one-sixth the size of TD Waterhouse, has turned in disappointing returns since Bank of Montreal bought the business from Credit Suisse First Boston in late 2001 and combined it with an existing direct investing business.

Late last year, BMO set out to turn the business around. In addition to simplified pricing of $7.95 a trade, a large part of the transformation is a focus on wealth management.

Harrisdirect is rolling out a "guided investment model" that will offer various levels of investment advice and tools at different price points. Clients can access basic advice to set goals and allocate assets according to model portfolios. They'll pay more if they want help selecting investments through proprietary models, recommended lists and portfolio construction tools. The full package includes portfolio management assistance through alerts and reports on performance.

At a conference in Chicago this month, executives from BMO and Harrisdirect played up the connection between the bank and the discount broker. Since both are already in wealth management, online portfolio management tools can be created to tap into expertise without a substantial increase in costs, they said. But some company watchers say pressure from the much-larger TD Ameritrade will result in the sale of Harrisdirect for as much as US$500-million before it reaches any of those goals.

E*Trade Financial Corp., the New York-based discount broker that sped up industry consolidation this summer with a hostile bid for Ameritrade, has taken a different approach to minimizing reliance on trading commissions. It started an online bank.

A source close to the TD-Ameritrade negotiations said the online banking unit, now a substantial part of E*Trade's operations, played against it in the three-way merger contest because online banking is not as prized as wealth management.

E*Trade could still try to break up the TD-Ameritrade marriage. But industry players say a more likely scenario is a merger with Schwab, which has become a big player in wealth management.