Remodeling Wall Street
Online trades. Extended hours. A stock market going public. Investing
NEW YORK — Forget short-term shakeups like Friday's market plunge. Wall Street has heard the jackhammers of dramatic long-term change. Some securities-industry firms are expected to get lost in the rerouted traffic as new, more agile competitors pick their way through.
But ordinary investors could drive clear of the technology-driven rubble with improved services at lower costs.
"Customers always emerge as winners," says Hamid Biglari, a consultant with McKinsey & Co., in New York.
What no one seems to doubt is the magnitude of the change. "Biggest revolution since the Great Depression," trumpeted The Wall Street Journal.
Faced with increasing competition and an avalanche of stock trading on the Web, the major exchanges are changing the way they do business.
The remodeling comes at time of plummeting trading costs and a soaring number of trades. Enticed by the bull market, individual investors have returned en masse to stocks. If they are keen, they can trade day or night.
Trading of stock on the Internet has boomed. Since the start of 1997, online trading has grown from about 7 percent of all US stock trades to some 16 percent earlier this year.
Approximately 30 percent of the volume of trading on NASDAQ bypasses traditional brokerages and is instead online through nine electronic communications networks (ECNs).
If possible, ECNs match orders to buy and sell in their own computerized operation. If not, they are sent to brokerage houses for handling, usually by NASDAQ dealmakers or New York Stock Exchange floor traders.
"We have grown six-fold in the past 12 months," boasts Kevin Foley, chief executive officer of one ECN, Bloomberg Tradebook.
Wall Street is now trying to figure out how to integrate ECNs, with their low costs and faster execution of orders, with traditional stock markets.
Some major brokerage houses have hedged their competitive positions by investing in ECNs.
Merrill Lynch & Co., the nation's biggest brokerage firm, has a grand plan for entering the electronic trading business. On Dec. 1, it aims to launch an online service where customers can trade stocks, bonds, and mutual funds - and do some e-shopping.
Frank Baxter, chairman of Jefferies & Co., an institutional brokerage firm based in Los Angeles, has a dinosaur poster on his wall with the slogan, "Adapt or Die."
An exchange stock?
To compete with at least nine nimble ECNs, the world's biggest exchanges, the New York Stock Exchange (NYSE) and NASDAQ, plan to shift from institutions owned by their members to profitmaking corporations.
Officials at these exchanges, are "no slouches," says William Freund, an economist at Pace University in New York who organized an Oct. 6 securities conference. "They will move decisively and swiftly to meet their competition."
This new corporate status, exchange officials say, will allow them to buy an ECN and to make strategic decisions more rapidly than at present. But regulators are concerned that maximizing profits may not always square with the interests of investors.
Competition all day, all night
Wall Street also plans to expand the hours for trading stock. The floor of the NYSE is now open from 9:30 a.m. to 4 p.m. The official hours for NASDAQ and its recently acquired American Stock Exchange are the same.
But these exchanges are planning to keep open their systems that distribute quotations - either the last sale or the best bid and offer on their listed stocks - until 6:30 p.m. The move could come as soon as next week and will likely assist existing after-hours trading in other trading facilities across the US.
At present, a number of ECNs and online brokerages already allow trading during a hodgepodge of hours before and after official hours at the older exchanges.
Among the latest, Boston-based Fidelity, the nation's biggest mutual-fund firm, announced Oct. 7 it would next month allow online investors to trade until 8 p.m. Charles Schwab made a similar move earlier that week.
Wall Street expects that 24-hour trading is coming. Many brokers aren't happy at the prospect.
"It will play havoc with tennis and golf scores," jokes Leopold Korins, president of the Security Traders Association.
So far, investor demand for longer trading hours has not been overwhelming. There are also concerns about thin trading volume, volatile prices, and poor information in after-hours trading.
"People aren't staying up at night to trade. But if people like it, that's fine," says James Freeman, head of Freeman & Co., a strategic consulting firm in New York. "Maybe it's an alternative to watching TV."
Most stock shoppers have kept plenty busy during regular trading hours. From 1991 to 1998, average trading volume grew from about 60 million shares a day to nearly 800 million on NASDAQ, and from under 200 million to nearly 700 million on the NYSE, where the shares of most big companies are listed.
Smaller trades in bigger numbers
Another change on Wall Street's drawing board: plans to convert stock prices from fractions of a dollar to decimals.
Stock prices now move in a minimum increment of 1/16th of a dollar, or 6.25 cents, and are quoted in terminals and newspapers in fractions. Starting next July, 40 stocks will be bought and sold in 5-cent increments. The plan calls for trading in all stocks in any increment, as low as a penny, beginning Oct. 2, 2000.
Wall Street dreads the shift.
It suspects the new system might strain its computers as trades and orders to sell or buy at specific prices multiply. Also, earnings could tumble with potentially smaller commissions or smaller spreads between buy and sell prices.
Complicating matters, more individual investors are taking a different approach to trading, buying stock directly instead of through professionally managed mutual funds.
Since 1995, small trades (under 2,100 shares) as a percentage of total NYSE share volume have grown from 18 percent to somewhat under 23 percent (see chart, page 14).
The remaining, larger trades are made by institutional investors, such as mutual funds and pension funds.
At the NASDAQ, the average trade size has shrunk from close to 1,400 in 1995 to about 800.
"It's growth from a bull market," says Mr. Freeman. "How much of that will last with the arrival of a good bear market, I don't know."
With many stock prices falling in recent months, small trades have decreased a little.
Fallout for investors
One likely benefit from the changes on Wall Street will be a further reduction in the costs of trading stocks. Commissions per dollar of stock traded on the NYSE have fallen from almost 0.5 cents in 1990 to not much more than 0.2 cents last year (see chart, page 14). Broker revenues from the spread between buy and sell prices has dropped in the same time frame from a little more than 0.3 cents per dollar of NASDAQ trading volume to 0.1 cents.
That's a reflection of the competition in the price of trades by discount brokerage firms, electronic trading operations, and changes in order-handling rules imposed by the SEC in 1996 on NASDAQ trading.
Decimalization and e-trading are expected to shrink trading costs even further. And as trading costs fall, price volatility will rise, says Mr. Biglari.
"Investors will really need to understand what they are doing in the marketplace," he says. "The risk of significant losses will increase. It will require much more savvy."
With stock prices on a general uptrend since October 1987, many investors have never experienced an extended bull market. Often they trade stocks frequently and, because of generally rising prices, manage to make profits.
"Most people are gambling, and they think they are investing," says Biglari. Investors should think more of long-term values.
Meanwhile, those within the securities industry question who will survive the upheaval.
They wonder if the auction market on the floor of the NYSE - where brokerage house traders shout orders - can survive the onslaught of electronic trading. One Wall Street executive joked that someday the huge floor space of the 207-year-old institution will be turned into expensive condominiums.
But some analysts argue that two people bargaining can find a fairer price for large trades than an automatic computerized process.
(c) Copyright 1999. The Christian Science Publishing Society