Today the majority of Americans have access to the Internet. In most cases, the speed of their connection is significantly higher than 56 kbp/s. When this verity is combined with the notion that America was founded on the basis of capitalism, and that money is a vice that the majority of Americans desire more of, it makes sense that securities trading would eventually transition into an online environment. During the last ten years, the digitalization of every aspect of the securities markets has greatly increased the efficiency and speed with which professionals in the business operate. Traditionally, when an investor wanted to place an order for a security[1], he or she would have to contact their registered broker, usually by phone, and place the specific order with that person. The broker would then send the order, either by person or by phone, to the floor of the stock exchange. This could only be done, however, after the broker received his or her, oftentimes several hundred dollar, commission. At the floor of the exchange, a representative would “cry out” the order at the booth where that particular security was being traded, in hope of finding a matching bidder or seller for the same amount of that security. Clearly, such a process contains an excessive number of middlemen, and requires the use of far too many resources, both monetary and physical. Over one hundred years after this process began, however, it ended with the electronification of almost every facet of exchange trading.
The entire process of offer-bid matching is done electronically now. As such, the need for calling a broker to place an order in your name has virtually disappeared. Typically, a full-service broker is one who receives a phone call from a client wishing to place an order for a particular security, and who then passes that order on to the market. An online broker, on the other hand, allows investors to place their orders via a web interface, and those orders get sent directly to the market without an actual person ever seeing them. This is where the controversy which is the topic of this paper, results. The fact that nobody is standing by to monitor what investors do with their money is a problem. Howard Abell, Robert Koppel, and Ken Johnson are all trained professionals that have years of experience with the markets. Together they remark at how “the vast majority of Americans who owned stocks relied on a personal broker for advice, recommendations, and trade executions” (22). What they mean is that brokers were used for much more than placing orders for customers. They served as advisors, who, with a wealth of knowledge would inform clients about what their investment strategies should look like and what actions would help them become the most successful in the markets. With regard to investing through a broker, Charles Carreon, an editor at 401kinvestor.net, articulates “this a good idea for ignorant investors.”
Trading on the stock market is a task that requires much skill and very little luck. Some people relate the act of investing to that of gambling. Brendon Seeto, in his book The Psychology of Online Trading, supports this notion by saying, “as consumers are given the opportunity to trade online, the difference between casinos and online trading companies has decreased” (43). For most newbie and inexperienced investors, investing practically is gambling. Most new investors haven’t the faintest idea as to what they are doing when they begin trading. Traditionally, this is where having a personal broker helped guide these individuals toward making smart investment choices. With the advent of electronic trading facilities, however, this added layer of investor security has disappeared almost entirely. There is much greater availability, as a result, for first-time investors to try their hands at the market, an activity that required too much time and money before online brokers made trading as cheap as $5 a trade. For about ten to twenty times that much, it is possible to have a trained professional review your portfolio, yet most people are not willing to pay a fee that is mammoth in comparison to the cost of making a trade. True, it is much cheaper to invest online without going through a certified professional, but the problem here is simply that- there is no professional guiding you through the experience. Dr. Victoria Collins, a Certified Financial Planner (CFP), relates newbie investors’ experiences in other facets of life to their enthusiasm to invest: “The idea of consulting a full-service broker or other professional for investment advice seems strange to them…because they’re used to being independent in other areas of their life” (InvestBeyond.com 11). These first-timers do not believe in asking for help—after all, they are grown-ups. Being an adult, however, does not mean that one is automatically bestowed with the wisdom to act in a capacity similar to that of, say a CFP. Such a title requires years of training, certifications, and licensures in order for a person to be deemed truly knowledgeable of what they are doing in the expansive world of money markets.
The fact that so many new investors lose vast sums of money through market exploitation via the Internet points to “the need for the establishment of investment analysis as a profession with its own academic standards,” as John Goodchild and Clive Callow, experienced investment strategists, put it (Double Takes 76). There needs to be a set level of expertise in investment know-how, by which investors can call themselves “informed.” Assuming that such a standard is set, that knowing all about security types and investment strategies designates you as educated in the field, the level of application of such a standard becomes an even greater topic for debate. As it stands now, in order for a person to sell securities to individual investors, and to manage money for them, they must have passed two examinations called the Series 7 and the Series 63. In order to pass these exams and obtain state licensure, individuals must be well educated in almost every facet of investing and money market activities. These individuals, as a result, manage money for others once they have ascertained a sufficient knowledge base. New investors, under current statute, are not required to know anything about investing whatsoever in order for them to be allowed to invest, online or elsewhere, unsupervised. Clearly, a discrepancy is present in the arena of money management. As Abell, Koppel, and Johnson insist, “the emergence of the self-directed electronic trader brings with it an overwhelming need for training” (xiii). It is agreed upon by many that the need for training in the field of online investment is greater than ever. The way traders think has completely changed, as the psychology behind market behavior has changed with the utilization of the Internet for almost all trading activity today.
There is no doubt that the implementation of the Internet’s vast resources has helped thousands of investors in ways unimaginable. On the contrary, the Internet has proved to be quite a detriment to many new and experienced investors alike. With the spread of the Internet as a tool for learning about investment opportunities, an expert analyst like Brendon Seeto has seen many investors act on false or speculative information, noting that “information from electronic trading systems…distract[s] market participants from their basic investment principles” (ix). Because these investors get distracted, they end up “not taking the time to properly evaluate any [security] before buying,” says Dr. Victoria Collins. Here she is outlining what she believes is one of the greatest downfalls of Internet trading: lighting fast trade execution times (25). The Internet has reduced the average trade execution time to only 2 seconds for most securities, and as a result, traditional principles that once guided rational investing behavior have gone out the window. Instead, hype and euphoria have begun to surround the environment of online trading that give the impression that instant, unlimited profits are only a few mouse clicks away. As a result, new investors get an entirely incorrect perception of what the market is and how it works.
The way individuals think when they invest has changed with the simplification of the investing process. This shift has occurred almost exclusively through the exclusion of full-service brokers from today’s transactions. It is far easier now to access the market and be fooled by its pretty charts and seemingly endless potential for profit. Brendon Seeto, on get-rich-quick schemes, reminds us that “one of the major advantages of electronic trading is that it allows…access [to] the market in seconds” (6). As it stands, this is an amazing feat. However, because it only takes seconds to trade, it takes just as little time to lose an equally amazing amount of money. Still yet, people cherish the ability to do what they wish with their own money, when they want to do it. As Collins tells us about the freedom of individual choice that people have enjoyed all their life, “after buying cars, houses, and insurance this way, they’re now moving into investing” (11). As convenient as Americans enjoy their lifestyles, those who begin investing on their own generally don’t do the research to substantiate their trading strategies. Abell, Koppel, and Johnson inform us that “from 1992 through 1998, it has been estimated that eight out of every ten people who tried “day trading” lost money-sometimes big money” (35). The phrase “day trade” implies the quick buying and selling of securities that wouldn’t be possible without the use of the Internet. What these grotesque numbers are saying, therefore, is that newbie traders need more preparation before they attempt to “day trade,” or trade at all for that matter, using the advanced resources the Internet has to offer.
The US government owes it to its citizens to protect them from unwarranted risks, in this case with regard to the financial sector and regulating the online trading of securities. Having established that most newbie investors perform incredibly poorly in the market, and that the risks of trading have multiplied exponentially with the advent of lightning fast Internet capabilities, the US government should implement a system whereby all investors wishing to invest online in monetary instruments and financial securities are required to pass a comprehensive examination covering material related to the field, before they are allowed to do so. Collins points out that “some of these new electronic do-it-yourself investors really do know what they’re doing, often as a result of having moved through the ranks from full-service broker to discount broker to today’s online discount broker” (11). This is definitely true in the case of some traders, however the overwhelming majority of new online investors have no idea where to begin in the trading arena. Collins goes on to admit that “at the other end of the experience spectrum lie the new investors who only recently acquired enough assets to invest in stocks or mutual funds” (11). For this reason, these new investors are only just beginning to invest, and have no experience in trading with or without a full-service broker, or someone to look over their shoulder. Rarely is there a new investor that understands “the analysis of economic data, statistical forecasting, stock market psychology, investor requirements and portfolio selection,” as Goodchild and Callow point out require an adequate understanding by any person wishing to be even remotely successful in the market (76).
An adequate understanding of myriad concepts would be imperative in order to obtain a modest level of skill and understanding of the workings of financial markets. Some people are better at investing than others, however no one is born with the innate ability to pick stocks or manage money. Investing requires learnable skills. Abell, Koppel, and Johnson agree that the three criteria for success in the markets is learning “where to trade, how to trade, and what to trade” (37). Essentially, an examination geared toward preparing individuals to trade securities online without the supervision of a broker, would cover these three, broad, facets. To take a closer, in depth look at the kind of education that would be required to pass an exam like this, it is important to understand the three types of market analysis: fundamental, technical, and sentimental. Dr. Melvin Pasternak, the editor of www.streetauthority.com, explains that fundamental indicators have to do primarily with “a company's sales and earnings outlook.” This is almost the exact opposite of the technical analysis, which is the evaluation of price fluctuations in securities’ values determined by studying charts. In an entirely separate category is sentimental analysis, which involves understanding the psychology of market participants. Clearly, market analysis is a complex and diverse arena that, without training, would never make sense to a beginning trader. To further complicate the process of understanding what information matters and what doesn’t in the financial marketplace, the Internet has introduced an entirely new means of disseminating data, “characterized by a series of tempting distractions,” professional analyst Michael C. Thomsett puts it (Mastering Online Investing 1). Anyone with an Internet connection can publish information concerning any subject, and in most cases, this information is unverifiable.
Useless information and general ignorance are not the only prevalent risks to new investors, however. Mistakes and vulnerabilities, big and small, appear all the time when computers enter the picture. For example, a keying error caused either by mistyping or by dropping something could execute a trade accidentally, leading to undesired consequences. True these flaws are characteristic of all people human, but untrained investors are exposed to a different kind of risk far greater than what any accident might cause. The risks associated with security surrounding online banking accounts are various and many. Simply using a public terminal to check a portfolio’s status can be the downfall of a new investor. The government’s safety guide to online practices, found on OnGuardOnline, will tell you that experienced patrons of the online trading phenomenon know better than to access their accounts through public terminals, log-on without adequate virus protection, make their passwords too simplistic, or use public hot-spots to check their finances (OnGuardOnline). This is a lot to worry about, and it merely adds to the stress that traders experience already. The newest traders, who have yet to learn how best to manage the stresses of trading, are especially prone to forgetting these essential security measures. The most paranoid can even get a security token that attaches to their car-keychain and that generates “a one-time pass-code that typically changes every 30 or 60 seconds,” and is required to access an account. Not every vulnerability that the Internet yields, however, can be safeguarded against. Given the numerous complexities already surrounding the act of online trading, security is just one more measure that newbie investors have to worry about, and should be required to learn about.
By being required to pass a test that certifies competency in a diverse range of investing principles, new and old traders alike will be much better prepared for business in the financial marketplace. Just because an investor has passed the certification examination, however, does not guarantee that they will find ultimate success. Several skills in particular develop only with time and experience with trading. Most importantly is a cold, rational view of the market. When investors become caught up in the emotions of a large loss or gain, they many times act in irrational ways and ultimately make the situation worse for themselves. For example, imagine that a first time investor spends his entire life savings buying stock in Pfizer, a major US drug company. He wakes up the following morning to find that Pfizer has announced the failure of its highly anticipated heart drug, and suddenly this new investor is out 13% of his investment. Generally, a person in this situation will lose some of their sanity, and feel that they have to make up for their loss somehow as they begin buying random, highly volatile stocks left and right, all because the speed of the Internet allows them to. In the end, this investor is out of 20% of his investment, significantly worse than before. It is imperative that an investor be able to keep his sanity, no matter what situation he may find himself in. Developing a cold view of the market is essential to overall success and rational decision making. Essentially, some investors are simply not suited to online investing, and should leave the management of their money to someone else.
The freedom that the Internet has created for individuals to make their own, unsupervised investment decisions has made it more risky and difficult than ever for inexperienced traders to earn consistent, positive returns on their capital. Abell, Koppel, and Johnson point out that, “despite their enthusiasm, most people entering the markets today simply do not have the skills and experience to trade effectively” (xiii). The resources that the Internet has made available to investors have proved both helpful and detrimental. Useless and incorrect investment data has flooded the information superhighway, and the speed at which investment transactions now take place lets investors act in mere seconds. Likewise, the simplification of the investment process with the Internet, through the exclusion of full-service brokers, has made it even easier for new investors to mismanage their own money. The Internet has become a marvelous tool for investing, but as expert investor Leslie N. Masonson says, “for today’s neophyte day trader the odds of success are slim to none” (Day Trading on the Edge 14). As a result, a strong need for training in the discipline of online investing is apparent. Additionally, new investors simply do not understand the skills, risks, and discipline associated with online investing, and, as a result, are too ignorant to sufficiently manage their own investments.
Works Cited
Abell, Howard, Robert Koppel, and Ken Johnson. The Sixth Market. Chicago: Dearborn Trade, 2000.
Carreon, Charles. "Mutual Funds." 401KInvestor.Net: Charles Carreon's Simple Guide To Investing. 9 Apr 2007
Collins, Victoria. InvestBeyond.com. Chicago: Dearborn, 2000.
Goodchild, John, and Clive Callow. Double Takes. Chichester, England: John Wiley and Sons Ltd, 2000.
"Investing Wisely Online." OnGuardOnline: Your Safety Net. Sep 2006. 26 Apr 2007
Masonson, Leslie N. Day Trading on the Edge. New York: Amacom, 2001.
Pasternak, Melvin. "Technicals versus Fundamentals." Street Authority. 18 Apr 2007
Seeto, Brandon C W. The Psychology of Electronic Trading. Singapore: John Wiley and Sons (Asia) Pte Ltd, 2004.
Thomsett, Michael C. Mastering Online Investing. Chicago: Financial Publishing, Inc., 2000.
[1] For the purpose of clarity, an order can be to buy or sell a security. The “market” simply refers to the place where securities are exchanged. Likewise, securities that can be exchanged include stocks, bonds, mutual funds, and a small slew of other, more complex investments that generally just combine one or more of the above.
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