This article concerns securities trading on the Internet or Online Trading. This method of trading evolved as technological advances changed the way in which investment products are bought and sold. With the advance of technology, securities trading in general became more automated. Moreover, as the Internet expanded, it became a marketplace for a variety of consumer goods which led to the creation of an electronic securities trading market. In the beginning, discount brokerage firms developed software that enabled customers to buy and sell securities online. The online trading industry continues to evolve as brokerage firms and other financial institutions are offering more traditional investment services while providing other financial services as well, and social media platforms and cloud-based data storage are now affecting how online trading is done. This article is an overview of the evolution of online trading and includes a discussion of new trends in the ever-growing field of securities trading.
Keywords Asset Valuation; Commission; Day trader; Discount broker; File Transfer Protocol; Internet; Internet Service Provider; Limit Order; Margin; Market Order; NASD; NASDAQ; Net Worth; New York Stock Exchange (NYSE); Online Trading; Patriot Act; Risk Management; Sarbanes-Oxley Act; Securities and Exchange Commission (SEC); Stocks; Stop Loss; Time Value; World Wide Web
Finance: Online Trading
The Internet has become a convenient avenue for people to conduct a variety of consumer and financial transactions. The ability of customers and commercial enterprises to exchange information electronically allows for credit card and utility payments, the purchase of and payment for consumer products, bank account maintenance, as well as for conducting financial transactions — including the buying and selling of stocks, bonds, mutual funds, and other investments. These financial transactions are commonly referred to as online trading. In order to understand online trading, a brief history of the evolution of the Internet and technological advances in securities trading are worth considering.
The Internet is the worldwide system of computers that exchange information electronically. The system was originally developed by the United States Defense Department in the 1960s in order to create an information exchange system that would enable key government agencies and the military to route data around failed electrical circuits in the event of a nuclear attack. By the 1970s, colleges and universities started accessing this information-exchange system in order to share research data. While the Internet remains largely unregulated, there are various standards and conventions, such as the File Transfer Protocol (FTP) and the protocol commonly known as the World Wide Web, that govern the storage, retrieval, and exchange of information.
Websites became more popular throughout the 1990s as numerous commercial enterprises began to exchange information and to communicate electronically through email with the assistance of such pioneering Internet Service Providers (ISPs) as America Online, CompuServe and Yahoo. Today, there are a number of ways to access the Internet and there are a broad array of services available that provide access to free information, data, software, games, consumer products, and banking and investment services (Russ, 1996).
As the Internet evolved and the information age began to advance, changes were also occurring in the way in which financial transactions were being conducted. This can be seen, in part, by the creation of NASDAQ — the electronic stock exchange established in 1971 by the National Association of Securities Dealers (the NASD). NASDAQ stands for National Association of Securities Dealers Automated Quotations System, and it is the market where most growth company stocks such as technology stocks are traded. Shortly thereafter, in 1975, the U.S. Congress deregulated the stock brokerage industry and one major change was the elimination of the New York Stock Exchange's (NYSE) ability to set commission rates charged by its members. This led to the establishment of discount brokers, who took orders to buy and sell securities, but these companies did not offer investment advice or perform research. Since the administrative expenses were far less than those incurred by traditional brokers, this new breed of brokers was free to offer buy and sell services at a discount (Stefanadis, 2001).
In addition to limiting their services to placing buy and sell orders for less money, discount brokers attracted a more savvy group of investors. These investors were quite often people who were employed in the financial services sector or who had experience with investments and were looking to trade for their own accounts. They also had the time and ability to perform their own research as well as to conduct due diligence. In order to do so, an investor needs to have an understanding of the basic concepts of finance such as the time value of money, asset valuation, and risk management. Moreover, these investors need to be able to analyze financial statements of publicly traded companies in order to determine their net worth, profits, losses, and revenues, all of which are critical to asset valuation.
As the demand for services of discount brokers began to grow, these companies began to develop software programs and construct hardware platforms that enabled investors to actually conduct financial transactions in real time over the Internet. These investors came to be known as day traders. Day traders are investors who buy and sell stocks during the day with the goal being to make profits as the value of those stocks changes throughout the day (Landis, 2004).
In order to do so, day traders use money that is borrowed, and this is known as buying on margin. Buying on margin is not a new practice as financial service professionals, investment companies, and sophisticated investors have bought and sold stock on margin for quite some time. Moreover, buying on margin is a practice that is regulated by the New York Stock Exchange (the NYSE) in conjunction with rules established by the NASD. However, it is a risky practice and an inexperienced investor can suffer large financial losses. While there were pre-existing regulations in place governing margin transactions, in April 2001 the NYSE promulgated stricter guidelines for margin trading being conducted by day traders (SEC, 2005).
The advent of online trading by the discount brokerage firms led to the establishment of new business enterprises that specialized in conducting stock transactions on the Internet. Some of the early companies in this field were Charles Schwab Corp., Fidelity Investments, TD Waterhouse, E*Trade and Ameritrade (TD Waterhouse and Ameritrade eventually merged to form TD Ameritrade). Not only did these entities lead the way in developing a new form of securities trading and establishing a new type of business enterprise, they have also had an impact on the greater financial services market by branching into more traditional consumer finance services like check writing, electronic bill paying, and issuing credit cards and debit cards (Snel, 1999).
The NYSE and the NASD, as well as the U.S. Securities Exchange Commission (SEC) along with other state regulatory agencies, all regulate the securities industry as had been the case prior to the development of the Internet and the advent of Online Trading. Moreover, the early twenty-first century has been a period of increasing regulatory scrutiny of the financial services sector. Important developments in this regard have been the increased financial reporting requirements of the Sarbanes-Oxley Act of 2002 (SOX), the compliance requirements of the Patriot Act, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, and the Jumpstart Our Business Startups Act of 2012.
The Sarbanes-Oxley Act is a federal law that requires publicly traded companies to file yearly financial statements more promptly than in the past (prior to SOX, firms were required to provide annual financial statements 90 days after the end of fiscal year; the requirement is now 45 days). Publicly traded companies are also required to provide quarterly financial statements, and senior management is required to attest to the accuracy of these financial statements. The Patriot Act became Federal law in October 2001, shortly after the events of September 11th. The Act incorporates previous laws aimed at curtailing money laundering and bank fraud and its intent is to prevent the financing of terrorist activities by requiring financial institutions to verify customers' identities. This has had far reaching implications for investors and companies alike, especially as it relates to online trading. For investors who trade online or otherwise are involved in buying and selling securities, having quicker access to financial statements, and the increased...
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