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How to play the game

Online brokerages offer low prices and fast service, but care is still needed. The devil, as always, is in the details.

Online trading may sound appealing, but investors should educate themselves and be aware of the pitfalls before they get started.

For starters, there is a staggering number of online trading firms from which to choose. During the past five years, about 100 online brokerages have emerged.

Online brokerages include high-profile sites such as E*Trade, brick-and-mortar firms with an online presence such as Charles Schwab, and lesser-known brokerages such as MyDiscountBroker.com.

But before consumers choose an online brokerage, they must answer some basic investment questions, say industry executives and analysts.

"Do they need to stay with a full-service firm? There Online trading TOC are a lot of people who don't have the time to research their stocks. There are others that have no interest in picking stocks and some who have the interest and time but are terrible at it," said Blake Darcy, chief executive of DLJdirect. "It usually takes six months for people to figure out if they need to go back to a full-service broker."

Investors also need to consider whether they fall under the day-trader category or want to hold their stock for the long term. Some online brokerages offer services that cater to the active investor by offering low-price trades, while others concentrate service on long-term investors by offering comprehensive research tools, said Stephen Franco, an analyst with Piper Jaffray.

For example, deep discounters Suretrade and Ameritrade charge $7.95 and $8 per trade, respectively. Schwab charges $29.95 per trade but also offers more services, such as access to initial public offerings and mutual funds.

Investors can turn to several research firms to help select an online broker. Gomez Advisors offers a quarterly scorecard on Net brokerages, and Piper Jaffray also produces a quarterly report.

"[Investors] may want to try out several online sites. They should send an email to customer service and see how long it takes for them to respond. They should also study the prices and research offered," said Michael Gazala, an analyst with Forrester Research.

Investors might want to transfer a small portion of their existing portfolio to an online service to try it out, added Darcy of DLJdirect.

Investors also should be aware of the potential

Ranking brokerages
E*Trade received the highest overall ranking among online brokerages for the third quarter by Gomez Advisors. Competitor Suretrade captured the No. 1 spot in the overall cost category and DLJdirect tied with E*Trade for the top spot for on-site resources. Listed below are the top three winners in each category based on a scale of 1 to 10.

Overall Ranking
E*Trade:
DLJdirect:
Datek:
 7.32
 7.23
 6.49

Overall Cost
Suretrade:
Firstrade.com:
Brown:
 10
 9.73
 9.67

On-Site Resources
DLJdirect:
E*Trade:
Wall Street E:
 8.82
 8.82
 7.56

Customer Confidence
Quick & Reilly:
NDB:
Waterhouse:
 10.00
 9.42
 9.13
Source: Gomez Advisors
pitfalls of online trading. These include any hidden costs, possibly unreliable information gleaned from Internet bulletin boards, and the lure of becoming a day trader because commission prices are low.

"With online brokerages, you don't have a broker who'll determine your long-term financial plan and make you stick to it," said Piper Jaffray's Franco. "Online investors can veer off their financial plan and turn into a day trader...Conventional wisdom is that people who trade frequently don't come out ahead, compared with the buy-and-hold mentality."

Although online trading commissions typically run lower than those of traditional brokers, hidden costs can make the bill higher.

"Some firms have simple pricing structures, while others charge an additional fee for confirming orders, or whether the trade was a market order or an [over-the-counter] order," said Darcy. "At some firms, there's a big price difference if you phone in your order or place the trade online."

Another concern that surrounds online brokerages is their reliability and speed during times when the markets are surging. A number of cases have arisen of investors suing their online brokerage firm over lost opportunities during volatile markets because the system was overloaded.

"It can be frustrating when you can't log on to do a trade or get a timely confirmation on your order," Franco said.

Last year, E*Trade was hit with a class action suit over allegations the company's advertising and business practices were deceptive. The complaint centered on the company's commission rates and its ability to execute transactions in a timely manner. This lawsuit followed two tumultuous days on Wall Street in late October last year when the markets posted their largest one-day drop and one-day gain, respectively.

Investors allege that delays occurred in logging onto the heavily trafficked E*Trade site, causing them to lose money. The case is currently in the discovery phase, which is expected to last several months, said Lisa Buckser, attorney with Bernstein, Litowitz, Berger & Grossmann in New York. E*Trade declined to comment while the case is pending.

E*Trade and a handful of the other online brokerage firms have since quadrupled their ability to accommodate a surge in customer use, said Alex Stein of Gomez Advisors. The number of firms that have substantially built up their systems still falls short of the majority, however, he added.

Meanwhile, cases of Internet stock fraud are on the rise, said John Reed Stark, chief of the Office of Internet Enforcement for the Securities and Exchange Commission.

"We've brought 61 cases since we started the unit back in 1995 and we've had 38 cases just this year," Stark said. "Most of these cases involved stocks, stock offerings, and unlawful touting of stocks without disclosing you're being paid to tout them."

Some of the methods used to hype a stock include spreading false information in chat rooms, on bulletin boards, and through bulk email, according to regulators. Online investment newsletters also are suspect when its authors receive compensation for touting a stock, they add.

"It happens all the time that investors fall for this. I don't understand why it happens when there's great places to go for reputable information," said Darcy. "I would use bulletin boards and chat rooms for ideas but then thoroughly research it myself."  

Go to: Big brokers enter the arena