Trader’s Narrative

Zecco is a new brokerage firm started in late 2006 that offers zero commission, online trading.

Sounds too good to be true! So how do they make money? Through advertising!

For those who were around during the bubble years, this is nothing new. In fact, often, I think that the whole “web 2.0″ is nothing more than the web 1.0 with a new paint job. Take the AllAdvantage zombie which is now called Agloco. But anyway, believe it or not, during the bubble years, there were firms who offered free brokage services.

As you’ve probably guessed by now, they’ve all long kicked the can. Which says a lot about this business model. Lets see, there was FreeTradez.com which didn’t even get off the ground because they failed to comply with NASD request of financial statements.

There were others who offered free market orders but charged a small fee for limit orders. In other words, they sold order flow. A big no-no today but quite ordinary back then. After all did you really care if your broker cheated you out of $0.50 a share when the intraday ATR was $25 or more?

Among these sellers of order flow was FinancialCafe.com which later on merged with another free broker, BrokerageAmerica.com in a futile attempt to forestall its demise.

So feverish was this trend that even well entrenched brokers got nervous that they were missing out on the new new thing. Ameritrade jumped in with a short lived division called FreeTrade.com

They offered free market orders but charged $5 for limit orders (again, selling order flow). Later they changed their commission rates a few times. At one point they looked pretty similar to today’s Zecco: they offered 20 free trades a month and then a laddered rate for transactions after that.

Of course, Zecco has the luxury of really deep pockets since it is partially owned by Morten Lund one of the billionaire entrepreneurs behind Skype. So I don’t think it is going away any time soon.

Although they are using technology to reduce costs, there is only so much you can do. One cost you can’t reduce much without damaging your business is customer service. This by the way has been the Achilles heel of Interactive Brokers for many years (although they have improved remarkably in recent times).

When I started trading I paid $60+ round trip (at a discount broker!) and being a total novice, I only realized after several trades that with my small portfolio, any potential profit would be handed over to my broker. So I understand people’s need to minimize trading costs. But I really doubt Zecco is the way to go about doing that.

The other consideration is that Zecco’s “free trades” is not without limits: they are capped at 10 a day, 40 a month and after that are $3.50 each. But most Zecco accounts are smaller than $25,000 and therefore, Pattern Day Trader rules apply to them.

If you’re using Zecco to trade (not invest) you will be frustrated with the limitations that PDT regulations impose. And may even lose money if PDT rules stop you from trading. If you have $2000 here’s how you can circumvent them, get 4 times intraday margin and trade all you like!

As Mark Twain quipped, “History doesn’t repeat. It rhymes.”

With the historic and surprising bearish AAII sentiment, I wondered about the “sheeple” index that I mentioned about a year ago.

This proprietary index of mine looks at the retail brokers web traffic and uses it as a measure of retail investor participation in the market. I look at the three most popular online brokers: ScotTrade, E-Trade (ETFC) and TD Ameritrade (AMTD). I ignore the more trader oriented brokers like Interactive Brokers (IBKR) and CyberTrader (SCHW) because I’m trying to only measure the activity of Mom’n'Pop investors who are casual in their market participation. I want to track only those who are less knowledgeable about the market and more apt to get swept up in the vicissitudes of the market, swinging from euphoria to despair and back again.

The graph shows the merger of TD Waterhouse (red line) with Ameritrade (yellow line) so the spike up you see is the new website coming online, replacing the old one. Anyway, in the graph you can see that the traffic for the different online brokers not only ebbs and flows as a group, it does an impressive job of reflecting the moods of the average retail investor out there. For example, notice how in the summer of 2004 the traffic hits a low just as the market was forming an intermediate bottom.

Click for Larger Graph

Alexa has several ways of measuring web-traffic. Here is another way (daily reach) that shows very similar patterns:

Click for Larger Graph

The retail investor has definitely been sitting this one out. Since early 2006, even as the market has powered ahead, less and less people have logged on to their online accounts to participate.

Interestingly, the most recent results for May are showing a dramatic uptick - but is it short-term noise or are the retail investors and traders beginning to enter the market?

The Alexa numbers are very erratic and this could very well be just a blip. Only time will tell. All we can say now is that it confirms the lack of love towards the market by the casual investor and trader. Which means that the market participants are for the most part commercials, institutions and professional traders battling it out.

Even more surprising, analyst buy recommendations are at a 10 year low for US stocks. This, eventhough we are seeing a powerful showing of earnings on Wall Street. Which is, in turn, helping to give this market a reasonable price/earnings ratio.

And finally, according to Commitment of Traders the small speculators are positioned short right now.