Nextrade and TradeStation
It didn't get to become a full-fledged stock exchange, but a Clearwater-based electronic trading network has ridden innovation and regulatory changes to success.
MARKET OPTION: John Schaible founded Nextrade with Mark Yegge. The company's "expirationless" options, Schaible says, give it "an opportunity to change the market."
In 1998, two Clearwater entrepreneurs launched an electronic stock-trading marketplace called Nextrade, an electronic communications network that enables stock buyers and sellers to trade among themselves, eliminating the middleman. In 1999, Nextrade's founders, John Schaible and Mark Yegge, took an even bolder step, applying to the U.S. Securities and Exchange Commission to convert Nextrade into a full-fledged stock exchange.
Schaible and Yegge figured a Florida-based stock exchange would provide welcome competition for the NYSE and other exchanges. It didn't happen. The SEC wasn't approving new exchanges.
Schaible and Yegge haven't been sitting on their hands for six years, however. First, Nextrade gained control of a patented "expirationless" option that Schaible says has given the firm "an opportunity to change the market." The options, called XPOs, are still mostly a curiosity, but Schaible says they will affect everything from hedging strategies to corporate money-raising and executive compensation along with the stock, currency and futures markets. "Any time it trades anywhere in the world, we'll get paid," Schaible says. Nextrade has licensed it to the Philadelphia Stock Exchange, and Schaible hopes it will debut soon there. The options would in essence be puts and calls with no expiration date.
Meanwhile, as Nextrade innovated, the SEC approved reforms -- perhaps most notably one demanding markets have rules and methods in place to ensure investor orders are traded at a price as good as or superior to what can be done by automatic trading -- forcing the major stock exchanges to modernize their old, manual systems. Following the rule's approval, Nasdaq agreed to acquire Nextrade's rival electronic trading platform Instinet, a modernization move. The New York Stock Exchange, meanwhile, said it would buy another electronic trading platform, publicly traded Archipelago.
Nextrade, though much smaller than either Instinet or Archipelago, is considered a likely next target as other exchanges update. "Consolidation is definitely on the horizon," says Harrell Smith, manager for securities and investments for research firm Celent in New York. "I wouldn't hazard a guess as to whom the appropriate match would be." His firm in an April report predicted manual exchanges Boston and Philadelphia, which like New York utilize middlemen, would have to "automate or die" and may develop the automated capability in-house or buy it by acquiring a small electronic trading platform.
Schaible in June said he couldn't discuss consolidation -- at least through July. "Watch us closely this year," Schaible says. "We're going to be very interesting this year." He says he's similarly restricted from talking about Nextrade's trading volume -- its market share is tiny -- and other numbers, other than to say, "We're going to have by far the most profitable year this year."
The SEC reforms have clearly driven change in Nextrade's direction. "From our perspective, the asset base of what we have here increased dramatically with the passage" of the new regulation, Schaible says.
Despite the changes afoot, Schaible still regrets not getting SEC approval for a Florida-based exchange. If Nextrade had gotten that approval, Schaible complains, the deal to license the XPOs to Philadelphia wouldn't have been necessary because the options could have been introduced on the Nextrade stock exchange.
"It's such a frustrating thing for me. If I had my own exchange today, the value we would be bringing to Florida -- it would be such a wonderful thing not just for the investors in Nextrade but for Florida."
A Side Road Onto Wall Street
TradeStation has capitalized on a niche market of heavy traders who want the same tools as big brokers.
TRADING TOOLS: Trading Tools: Talk of industry consolidation is common, but TradeStation Securities President Joe Nikolson says the company's technology allows it to succeed independently.
Plantation-based online brokerage owner TradeStation Group this year is continuing to rack up honors. It won positive reviews in Barron's ratings of online brokers; meanwhile, the February issue of Technical Analysis of Stocks & Commodities magazine made TradeStation sound like the movie of the year on Oscar night -- recognizing it as Best Stock Brokerage, Best Futures Brokerage and awarding it 10 other honors. Co-founders Bill and Ralph Cruz and President Salomon Sredni won the Florida Ernst & Young Entrepreneur of the Year award in the financial services category. Reward comes with recognition. TradeStation in the first quarter posted $3.8 million in profit on a record $21.6 million in revenue and a record 19,670 brokerage accounts, an increase of 43%.CRUZ CONTROL: Brothers Bill (left) and Ralph Cruz founded the company as a trading software provider but saw more opportunity as an online brokerage.
Though they founded TradeStation as a trading software provider, the Cruz brothers proved nimble at recognizing the emergence of the internet and converting the company into an online brokerage. They chose to avoid the siren call of the mass market and instead focused on the niche of active traders and day traders, the most profitable subset of investors.
TradeStation's software allows investors to emulate the tools of Wall Street trading desks by executing their own strategies with customized trading rules. An investor may notice, for example, that a particular stock, after falling for three days, seems to rebound for four days. Using TradeStation's plain English commands, he can construct a rule that would buy the stock on the third day and sell it four days later. He could back-test his hypothesis with 20 years of historical data, factoring in commissions and other costs. The software would even tell him whether the optimal choice would be a different time frame -- say, buy on the fourth day and sell after seven more. He then sets up his system to execute the rule automatically or just alert him when the scenario occurs so that he can act manually. Unlike better-known online brokers, TradeStation's system is software-based, rather than browser-based, and potent in technical analysis.
All that is arcane stuff to the infrequent investor but important to the relatively small pool of active traders and day traders -- and essential to TradeStation's profitability and survival going forward. Trade-Station accounts average 44 trades a month, compared to less than one for E*Trade, Ameritrade and Charles Schwab, Trade-Station says. Active traders mean strong commission revenue ($4,180 in revenue per account on average), better operating margins and bigger accounts. TradeStation charges 1 cent per share for the first 500 shares of a trade and six-tenths of a cent per share beyond that or $8 for 1,000 shares. It charges $1 per contract, with no minimum, in options trading and $2.50 per side, per contract in futures trading. The company says its average assets per equity account in the first quarter were $88,419, far above Ameritrade and E*Trade, though trailing the $147,562 at Schwab.
TradeStation still remains a bit player compared to its rivals, however. In the first quarter, it had a record 39,801 daily average revenue trades, a key industry measure, an increase of 17% from the year before. But Schwab had 191,000 daily average revenue trades in the first quarter. TradeStation's trailing 12-month revenue totals $75.9 million; its market cap in June was $338.5 million. Schwab's revenue, in comparison, was $4.15 billion, and its market cap stood at $15.2 billion.
Brokers large and small are feeling the pinch of falling commissions, but TradeStation's technology affords it some protection as brokers cut rates to attract customers and other financial institutions use trading as a zero-profit business to sell other services. "Because they're focused on a very specific active trader, they're able to differentiate themselves," says Tom Watson, a Forrester Research analyst. "They're in less danger of commoditizing their offering."
TradeStation's problem, instead, is the small niche of active traders. "There's only so many of them. Once you find them, it's tough to grow," Watson says. TradeStation Securities President Joe Nikolson demurs, saying plenty of room for growth remains. "I really think we haven't come close to achieving the numbers we can on the domestic active trader side," he says. TradeStation forecasts its second quarter will show growth with a pretax profit of $6.5 million to $8 million.
Later this year, meanwhile, Trade-Station will diversify its revenue stream by handling foreign exchange trades in-house. Next year it plans to roll out improved institutional services and also launch international trading. The stock at the end of June traded at $8.25 per share, slightly off its 52-week high of $8.86.
Consolidation talk is common in the industry, but Nikolson says TradeStation's unique technology makes it possible for it to succeed independently as other firms are pressured to find partners. "Our package really is unrivaled," he says.