Investing Online: The Benefits of Technology

Why Invest Online?
Online investment is the general concept of investment using internet based trading platforms, such as Questrade or Etrade. It wasn’t until the mid-to-late 1990s that online investment became readily available to individual investors, and it didn't take long for online trading practices to quickly outpace and replace traditional investment methods, such as full-service brokerages. This is due in part to the increase of personal computer ownership and the proliferation of affordable internet coverage. It is also in part due to the advantages that trading online offers.

The main benefits of trading online are the reduction of costs, greater control of investment tools and strategies, and the unparalleled convenience of remote access. Many new teaching sites have risen alongside the growing popularity of online investing, such as Investopedia, in order to educate people about these advantages, as well as to improve their chances for success.

This is not to say that investing online is without risk. As with any internet-based platform, each trading site runs the risk of losing (vulnerable) personal information to data mismanagement or disruption, whether it be unintentional or with malicious intent. There are also psychological factors to consider, such as an investor trading larger sums of money than they may otherwise invest, because the monetary value seems less significant through an online medium. Or that investors may make decisions that are less informed than they could with the assistance of an experienced investor, effectively reducing their portfolio to little more than gambling.

As with any up-and-coming technology, there are advantages and disadvantages that must be understood about the internet and its role in investing in order to adequately assess the lasting implications it will have on the lives of investors.

Approaches to Online Investment
There are two general methods to approach the actual act of investing online: investments with a third party, and investments through a third party. Though they sound similar, they vary a great deal.

The act of investing with a third party is the act of investing in general investment plans that are created, managed and held by that third party. Such plans primarily include mutual funds, but can also extend to RRSPs and pension funds, as well as any number of more specific trading activities that extend unnecessarily beyond the scope of this project, (such as commodities markets). Third parties that can be invested with are typically major banks or their brokerage equivalents, such as RBC Investing(link) or TD Waterhouse(link).

On the other hand, the act of investing through a third party is a method of utilizing the third party as a mediator, who will execute the investors desired market orders on their behalf. Because this service is something individual investors are all but incapable of fulfilling on their own, online brokerages charge a fee for each transaction they fulfill.

For purposes of this project we feel it is more pertinent to explore the latter approach: investing through a third party, an online brokerage.

Cost
When placing market orders of a stock there is a transaction fee associated with each purchase, and this fee varies from one brokerage to another. Transaction fees are flat charges for each order, independent of order volume (e.g. at $10/transaction: 20 000 shares from Company A costs $10, whereas 3000 shares from Company B and 4000 shares from Company C will cost $20).

Return on investment (ROI) is dependent on an individuals cash flow available for that investment, by definition. When this value is diminished by brokerage fees ROI is diminished in turn.

Online investing carries significantly smaller brokerage fees than traditional methods of investing, and has quickly overtaken traditional trading methods in terms of volume, in a remarkably short period of time. In Canada the average online transaction fee for a personal account containing less than $50 000.00 is approximately $12/trade, while the average transaction fee for an offline account is closer to $18-$20/trade.

Control
Full-service brokerages come with a number of services that are not only expensive to employ but are easily replaced by informed investment practices. The limit order is a common example of an advanced trading mechanism that can assist an educated investor make higher, more consistent returns with less risk - at no cost. The limit order is a market order attached with a conditional command that must be satisfied before the order will be executed. This process works by establishing a buy or sell threshold for the order such as a minimum price the stock must reach before the buy order is carried through, or the minimum price that a stock can reach before attempting to curb losses by selling immediately (this is commonly referred to as a stop-loss order).

The stop-loss is the most common type of order because it helps diminish the risk of a substantial loss in the case of extreme market volatility. Such orders are not without risk: it is possible that intraday volatility can cause a limit order to be "tripped" unintentionally, selling the stocks on the premise they were falling fast when they weren't. Despite this, high competition between online firms has resulted in the price for a limit order being brought in line with a standard market order. That is to say that while it used to be a service offered online for a higher cost, it no longer costs more than a standard market order when ordered from an online brokerage.

Convenience
A very long time ago, investing in securities required a face-to-face meeting with one's broker to develop a market order. Then came the telephone, and it revolutionized the way investing took place. It changed the nature of the brokers responsibility to more of a mediator and less of an analyst. With less time required with each client, brokers came to serve many more clients, and it became an exception to speak in detail with a broker for investment advice, rather than the rule. Then came the fax machine, which completely revolutionized long-distance communication between brokerages and Wall Street in New York, or Bay Street in Toronto.

With each major development in communication technology, the financial sector has used that technology to the best of its ability to better facilitate their trading.

The internet has changed the way that each investor interacts not only with major financial districts but also with each other. The market isn't just more convenient because trades can be carried out without ever speaking to a human being, or because trading can now be conducted discreetly from work or school. The development of the internet has changed the way investors discuss market changes with each other on a personal level (rather than filtered through a newspaper or with a select few friends will to speak on their finances).

It has changed the availability of annual reports and other company filings through electronic archives, such as EDGAR with the SEC in the United States, or SEDAR with the CSA here in Canada, revolutionizing and streamlining the fundamental analysis of companies and their stocks. It has redesigned the entire graphical functionality of stocks, mutual funds and index funds, revolutionizing and streamlining technical analysis. The internet has transformed almost every aspect of every market of every economy in the world, and this is all because the technology facilitates communication in so many different forms.

But mostly because its really convenient to check your stocks during lunch.

"Addiction"
Due to the increase in convenience of access to the internet, online investing can become very “addictive” for some individuals, in some sense like a “game”. Because online investing has no physical “barriers” to keep an individual away, online investing can become a very addictive activity for individuals. For example, if their first stock purchase gets them $2000 in a short period of time, individuals may start making more or larger investments while turning a blind-eye to the risks involved. We can compare this to people who start playing online poker for play-money, that after winning a few times (off increased winning odds), decide to wager some real-money and this often leads to quick (and sometimes very large) losses from both online poker and online investing. In addition, since online investing is much easier and faster to do, it can become very tempting to start making more trades more often and often as the internet is just a click away.



Novice Traders
First-time or inexperienced investors may get a false sense of security and/or overconfidence from online investing. Due to the wealth and abundance of “knowledge” on the internet (forums, search engines, investing sites, etc.), many individuals may be influenced to invest where they would not normally invest – like through the traditional usage and advice of a stock broker. These possible ill-advised decisions may lead to significant losses. Often new/inexperienced investors without the proper investing knowledge set unrealistic expectations in their investments, thinking that it is easy to make money without much risk (which is untrue). Although the internet has provided a vast amount of genuine and useful information to many individuals, there is also a lot of inaccurate or false information out there.

Security Risks/Scams
Although most online investing sites are very secure and protected, there is always the chance of personal and/or sensitive information being intercepted. One of the big online risks nowadays is “phishing”, in which fraudsters create a replica, authentic-looking website, which is designed to steal individual’s personal information that is entered. Also personal/investing/financial details stored as information databases on investment websites can possibly be hacked and stolen by hackers, and used for fraud purposes or identity theft.

Possibility Of Huge Loss
Enticing advertisements such as: “risk-free investing” or “$10000 in only one day” may lead individuals into false promises, and more often than not, losses on their initial investment. Like the saying goes, investors should follow the general rule..."if it seems too good to be true, it probably is". Online investing always involves some sort of risk.

Conclusion
While traditional investing permits individual investors to consult professionals about their stock picks, it comes at a high price. For most investors who stick to blue-chip stocks and mutual funds, the dramatic price decrease and independence factor encompassed by online investment practices has spurred an immense turnover to the internet for personal investment needs. Having more control over their portfolio develops more responsible, more capable investors.

Though the risks of trading online are certainly real, they are no different from the risks of many other applications developing in tandem with the internet, such as instant messaging or online banking. And the psychological aspects that encompass online investing can be generally reduced to an array of personal choices - how much to invest, when to invest it, and why.

Thanks to lower costs, more independence, and improved ease of use, online investing has completely undermined all other forms of investing media. Firms that didn't adapt to its implications ran out of business. Investors who didn't adapt got left behind. The fresh faces of finance over the coming generation and onward will likely never experience their version of finance in its traditional, outdated form.

So unless a faster, simpler, more accessible form of communication technology can be developed, investing online will certainly be here to stay.

Group Members
Jane Shi Zhang, Jedd Matechuk, Ryan Samuel Toy