HERE IS THE TEXT!!!!!!!!
April 5, 2000 12:11pm
Burnham's Beat: Ripping off the little guy, one trade at a time
By Bill Burnham ZDII
Every working day, hundreds of thousands of retail investors enter orders to buy and sell stocks and then put their faith in a system that they believe will get them the best price. The dark secret of Wall Street is that retail investors rarely get the best prices and almost everyone knows it.
While this issue affects almost all retail investors, it affects Internet investors the most. Net investors are active traders who play the most volatile stocks on the market. This activity provides ample room for Wall Street middlemen to make lots of money, often at the expense of their own customers.
Individual Investors: Getting burned?
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As a former Wall Street analyst who covered the online trading industry, I saw the emergence of these questionable trading practices, which have become an accepted way to do business. These practices are unfair to individual investors and highly questionable from both a legal and moral perspective.
The Rise of the Wholesaler
There are a number of trends that have pushed these practices to the forefront, but the most important is the rise of so-called ?wholesalers.? Wholesalers are large trading firms that aggregate orders from retail brokers and then execute those orders on behalf of the brokers and their retail clients. Indeed, many retail investors are often surprised to learn that their trade is not completed by their own brokerage. These trades are ?outsourced? to one of a handful of powerful wholesalers.
Today, these wholesalers have become the primary means by which almost all retail investor orders are executed in the market. Many of the largest wholesalers now account for 30 percent to more than 50 percent of the trading volume in particular stocks. Wholesalers also dominate trading in the hottest Internet stocks. (Ed note: Major wholesalers/market makers include Knight-Trimark (Nasdaq: NITE), Herzog Heine Geduld and Mayer & Schweitzer, recently renamed Schwab Capital Markets L. P.).
Orders = Information
When brokerages send their customers' orders to a wholesaler, they are sending them valuable information. That's because these orders represent intentions to buy or sell stocks at specific prices.
Professional investors, such as mutual fund managers, guard intentions to buy and sell stocks closely. If anyone in the market were to find out that a large mutual fund firm, such as Fidelity or Janus, was trying to sell a big position, the stock's price could fall dramatically.
Professional investors also try to prevent their own brokerage firm from finding out their true intentions. These investors realize that if a trader had knowledge of a big sale on deck, he would try to profit by buying or selling stock in advance of the order.
In the professional investing world, if an investor planned to sell 10 million shares, he would never tell the broker of his intentions. The professional investor would parcel out the trade in smaller increments to keep the brokerage firm's trader guessing.
The Power of Aggregation
At first blush, retail investors don't have the same problem. A decision to sell 100 or 1,000 shares in most cases won't move the market.
However, wholesalers can aggregate tens of thousands of orders in a particular stock. By aggregating all of the individual retail investor orders, wholesalers acquire valuable information that tops any information they'd get from professional investors.
As the wholesalers acquire orders, in many cases over 50 percent of the orders in a particular stock, it gets easy to determine whether a stock might go up or down.
Imagine the stock market as a giant jigsaw puzzle. If you have 5 percent of a puzzle's pieces in place it's tough to see the picture. When half of the pieces are in place, the puzzle is a no-brainer.
Once an experienced wholesaler controls 30 percent to 50 percent of the order flow in a particular stock, making money for its own account is like shooting fish in a barrel. The information used to make wholesalers rich comes from retail investors, who have no idea their information is being used at their own expense.
Indeed, there are now a whole series of widely accepted trading techniques used on Wall Street that are based on supposedly confidential customer information.
Part 2: Good Morning Traders: You're Screwed
Part 3: Online brokers to the rescue?
Bill Burnham is a General Partner at SOFTBANK Capital Partners and was a former Wall Street E-Commerce analyst. SOFTBANK is an investor in ZDNet. For more information on SOFTBANK Capital Partners and a list of current job openings, go to sbcap.com
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