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Sunday, 26 August 2007

Social Networking Hits Investing

By David Bogoslaw

For most equity investors, the wild market volatility of the past few weeks has been cause for gritted teeth and palpitating hearts. But a few who have become active in online trading communities took some solace in the fact that they at least had found a place where they can see how other investors are riding out the storm.

"Just the fact that I'm seeing people in there buying calls (an equity option that bets on rising prices) and common stock has definitely given me confidence that the individual is buying on the dip, which is basically what I do, and it's always good to get some reassurance that other people are doing the same thing," says Jim Collins, who opened an account at TradeKing.com in January.

Like many other parts of the Internet, online trading sites are more and more turning into collaborative experiences. Only one of the better-established discount online brokers, E*Trade Financial (NasdaqGS:ETFC - News), has made a foray into collaborative Web 2.0 capabilities with its acquisition of investment community Web site ClearStation in 1999, but a handful of newer brokers have made social networking a cornerstone of their platforms.

Getting Personal

Incorporating social media, or social networking, features such as message boards, blogs, live chat rooms, and podcasts works to the mutual advantage of both brokerages and their customers, says Brian O'Malley, a senior associate in the Menlo Park (Calif.) office of Battery Ventures Partners, a Boston venture capital firm that invests in emerging technology companies. Customers want guarantees that they're getting credible information from trustworthy sources, and brokerages realize their business will suffer if they can't ensure the legitimacy of the information and users on their Web sites.

The rise of trading sites centered on social media is seen by some as part of a backlash against the mass e-mails people used to get from unknown people promoting penny stocks and more often than not looking for a quick pop. But it also reflects growing demand for two-way flows of information.

"We see today's consumers aren't content to sit back and have their entertainment sent to them, or their news or, increasingly, to have financial advice sent to them," says Donato Montanaro Jr., co-founder and chief executive of TradeKing, which launched in December, 2005. "They demand to be part of the conversation that impacts their lives, and we are empowering that conversation." Investors in TradeKing include Battery Ventures Partners, and O'Malley sits on TradeKing's board of directors.

Investors Who Network Trade More

TradeKing allows all of its members to have their own blogs through which they can share investment strategies, or even thoughts about the political landscape that may affect future market conditions. The site's key innovation is its Certified Trades capability, which allows users to reveal what they have bought and sold and at what price.

Montanaro, who cut his teeth on trades as a licensed broker before being put in charge of all online trading at Quick & Reilly in the mid-1990s and founding SureTrade, is convinced the site's social networking features encourage actual trading. Roughly 2,000 to 2,500, or just under 5%, of TradeKing account-holders are really active, either blogging or publishing their trades. "That 5% makes up just over 10% of the site's revenue, so clearly investors who network more trade more," he says.

Customers pay a $4.95 commission for stock and ETF trades, and $4.95, plus 65 cents per contract, for options.For the first 13 months after the launch, there were just over 1,000 people who became really active and stayed active on TradeKing, and that has more than doubled over the past six months. Zecco Trading,, a division of Equinox Securities and part of investment community zecco.com, which launched last October, says it has been adding 1,500 new trading accounts a week for the past few months.

How Safe Are the Sites?

The number of funded and active customers at thinkorswim.com, which launched to its first customers in late 2000, has tripled from about 15,000 to 45,000 over the past 18 months. Granted, compared to the number of people with accounts at established discount online brokers, it's still very early days for the newer trading sites that are betting on the market potential of social networking.

The growing popularity of these sites raises questions, however, about the kinds of protection they offer investors from scams such as "pump and dump" schemes, and what they provide in lieu of suitability rules that registered investment advisers are required to follow. Those rules are meant to ensure that investors stick to appropriate trading strategies that match their financial circumstances.

Montanaro and Mike Massey, the company's director of community development, stress that TradeKing, as a brokerage regulated by the Financial Industry Regulatory Authority (FINRA), cooperates with regulators and updates them about new features it's thinking about adding to the Web site. Last August, it launched the certified trades function, which allows customers to see what other account-holders who choose to participate are trading, how many shares they're buying or selling, and at what prices. Perhaps more important, the certified trades feature assures customers that TradeKing knows that those participating are real people and has validated their identity.

The Electronic Paper Trail

"We know if someone blogging is the CEO of Whole Foods (NasdaqGS:WFMI - News) and is blogging about Wild Oats (NasdaqGM:OATS - News) and we know that he's got a greater than 5% interest in Whole Foods," Montanaro said, referring to the recent controversy involving the chief of the No. 1 organic supermarket chain. "Being a regulated entity, this would be a really stupid place to perpetrate a scheme because you're creating a trail attached to your name with a regulated entity," he adds.

Massey says his team reviews every blog entry and takes steps to remove comments that can be construed as unethical or potentially harmful to investors. "We try to be as light-handed as possible. In one or two instances, we have removed the user and taken down the content (he posted)," he explained. TradeKing says it has no specific suitability rules beyond the warnings listed under the disclosures and terms and conditions tabs on its site, which customers are supposed to read before opening an account.

Zecco Trading takes it a step further by requiring prospective customers, as part of the application process when opening an account, to fill out a suitability form that lists their investment history, income, experience using various types of financial instruments, and the options strategies they've used in the past. Based on those responses, Zecco Trading assigns each account-holder a specific level of options permission, which he needs to stay within when choosing strategies, says Tim Krause, director of risk management at Zecco Trading.

Something in Common

Zecco.com -- the name stands for zero commission costs -- offers free stock trading through Zecco Trading to customers for their first 10 trades a day and 40 trades a month. Options trades cost $3.50, plus 60 cents per contract. Its biggest revenue source is interest earned on margin borrowing by its customers, says Gabriel Dalporto, Zecco's chief marketing and strategy officer.

Zecco Trading also allows customers to see what other customers are buying and selling as part of the individual user profiles, which also include preferred trading strategies. Users can contact each other and form relationships based on shared stock interests or investment approaches.

For Tom Sosnoss, president of thinkorswim.com, 80% of those transactions are options. It's the very complexity of options, which don't lend themselves to clear black-and-white solutions, that encourages participation in an investor community. Although it has a Web-based platform, most of thinkorswim's functionality is in its software and 95% of its customers use the software, which is free.

Not Another Facebook

Through a sophisticated technology platform that includes live audio, enabling customers to go into separate rooms to discuss a particular strategy, thinkorswim, a unit of Investools (NasdaqGM:SWIM - News) that launched to its first customers in late 2000, emphasizes investor education, which it's confident generates more transactions.

"The thing that intrigues customers is they like to be challenged intellectually," Sosnoss says. "When they're challenged, options traders become a successful community."

But Sosnoss eschews the idea of "social networking," which makes him think of his teenage kids surfing Facebook. He believes the reason people are communicating on thinkorswim.com is to learn how to be more effective traders, not to gain a sense of community for its own sake. "We build trading networks. Really what it is, we build technology that drives domain knowledge. The way you do that is you provide a network for customers to interact with you, as well as with each other," he says.

Listening to the Feedback

But O'Malley at Battery Ventures Partners argues it's hard to start with technology and assume that people will adopt it. "You have to start with well-understood social practices. Then you try to take technology to facilitate those practices and adjust the technology as you roll it out, as you see how people are using the technology," he says. TradeKing has been refining the technology on its Web site since it launched. Many of the new features it will add in mid-September, such as the ability to turn on the certified trades function without revealing the amounts bought or sold, are based on customer feedback on the blogs.

Until now, TradeKing user Jim Collins hasn't used the certified trades feature. "The actual dollar amount is something I'm not comfortable showing, but if they get that functionality (to hide the amounts) up and running, I'm ready to go," he says.

Future innovations that Zecco and TradeKing are working on will allow investors to form groups centered around common stock interests or trading strategies. And farther down the road, TradeKing plans to roll out a tool that allows users to search returns on investment and see which customers have been most successful over time.

One sign of the refuge some nervous investors are taking in online investor communities is the jump in volume of option trading at TradeKing on especially bumpy market days, says Montanaro. "They get some comfort and validation. People enjoy seeing both sides of experiences when markets are especially turbulent," he said. But Montanaro makes it clear that any technological innovations that TradeKing adds will be to drive higher usage and therefore greater profitability.

A Tip From a Friend

Collins, who worked for 10 years on the sell side for brokerages like Lehman Brothers (NYSE:LEH - News) and Donaldson Lufkin & Jenrette (since acquired by Credit Suisse (NYSE:CS - News)), said he's been getting investment ideas from people commenting on his blog posts. When he reported an interest in engineering and construction companies and that he had a "huge win" from buying options ahead of Foster Wheeler's (NasdaqGS:FWLT - News) first-quarter earnings, somebody recommended Perini (NYSE:PCR - News) to him.

"(In the second quarter), the earnings went through the moon. I sold it with a 100% gain yesterday," he said. "Without that comment, I probably would never have unearthed Perini. That's a tangible example of an investable idea."

Whether these sites can truly unleash the wisdom of the crowd for market players remains to be seen. But you can bet that in investing, as in other corners of the Web, the urge for community will grow stronger -- and the bigger players in online trading may have to respond to upstarts like TradeKing and Zecco.

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