There’s an expression that bands around the city: “during the floor”.
It’s said in the tone of Uncle Albert from Only Fools and Horse when he would recount stories to Del Boy from “during the war”. It’s often used when old LIFFE floorers are boring on about their piped jackets back in the day, as though we should yarn for a return to the old open outcry floors.
The old dealing floors may well have been the “last bastion of pure capitalism” (according to Winthorpe) but electronic trading has been fantastic for traders, both in terms of flexible execution and pricing.
To be fair, I did had the privilege of working on the NYMEX and IPE floor (albeit it as a lowly intern clerk checking trading tickets) and one thing I can tell you is that we shouldn’t. Whilst it was fun, I would hardly call it a progressive environment. We should instead be eternally grateful to the pioneers of electronic trading who dragged the industry kicking and screaming out of the pits and onto the screens.
One of those pioneers is Thomas Peterffy, founder, Chairman and CEO of Interactive Brokers. He was one of the first brokers to push for the use of electronic screens on the trading floor to display prices.
Interactive Brokers has won business over the years by consistently offering discounted rates to private and professional traders. As of today, the shares are listed on the stockmarket with a market cap of just over $20bn.
Also, anecdotally, of course, I can tell you that apart from discounted pricing one of the things I know clients liked about IB is that they were the first to offer a multi-asset online platform from a single account. I had one particular Billionaire client at Man that we were always trying to lure back from IB with our friendly, manual, phone execution skills, but alas, we couldn’t offer everything under one trading platform.
Anyway, ten years on from that and as Thomas Peterffy prepares to step down as CEO we ask him what have been the highs and lows of the running the original, disruptive, online brokerage he founded over four decades ago.
Clearly, pricing and technology have played a huge part, but aside from that, what do you think has been the major appeal of Interactive Brokers?
You cannot overstate the importance of price which is not only our commissions that are about 60% lower than the competition but also the fact that we pay a high rate of interest, 0.5% under the interbank rate, or 1.9% in US dollars and equivalent in other currencies on cash in our customers’ accounts while most other brokers pay almost nothing.
Also, our margin loan rates start at 1.5% over the interbank rate and go as low as 0.3% for large borrowers. Other brokers charge two to four times as much.
The ability to open and fund an account in any of 23 different currencies and trade on over 120 markets that settle in 28 of their home currencies, without having to worry about currency conversions is a great convenience and a huge draw among our international customers.
We are also proud of offering futures and bonds in addition to stocks, options, Forex, ETFs and mutual funds, all on one screen and all in one universal account, and all at the lowest prices that we know of.
What have been your best, worst and proudest moments in the four decades since you founded Interactive Brokers?
I think my worst moment was when the Swiss Franc peg to the Euro was removed and the currency shot up by 20%. Many customers were short the Swiss Franc against the Euro on a 3% margin and had not enough money in their accounts to pay the losses. We had to immediately advance $200 million to cover these deficiencies and we are still trying to collect in many cases.
My best moments are every time when in a restaurant or at a social event somebody walks up to me and tells me how happy they are managing their account on the Interactive Brokers platform and how they regret that they did not come over earlier. These are the times when I feel the most accomplished.
My proudest moment is still to come. It will be when our platform will be generally recognized, worldwide as not only the least expensive place to manage money but also the most efficient, most versatile and the most fun.
Obviously, online trading is the norm these days, but there’s a great section in the Art of Execution by Lee Freeman-Shor that highlights some findings by Terrance Odean that suggested moving away from phone dealing to online trading can actually reduce performance.
I agree. But it is not because talking into a phone makes you smarter.
It is because talking into the phone is less convenient so you do it less often.
When you trade often, the execution cost mounts up.
A profitable trader must be able to overcome execution cost, which consist of commission, regulatory and exchange fees and execution slippage.
Commissions are complicated. They range from zero at some online brokers to about 10 dollars at others and to over hundreds of dollars at some phone brokers.
Most online brokers sell their customers’ orders to HFTs to execute.
The HFT makes enough money on the execution to retain a profit for themselves and to pay the broker and this is how some brokers can afford to charge zero commissions. (Large execution slippage).
To my knowledge, only Interactive Brokers and Fidelity do not sell their customers’ orders but seek the best price for their customers.
Fidelity charges $4.95 and Interactive Brokers charges $2.20 for a stock trade.
In our monthly metrics that come out the first business day of each month, we publish our customers total execution cost including commissions, regulatory and exchange fees and slippage. It is generally about one basis point or $4 on a thousand shares of a $40 stock.
It is this four dollars that a trader has to beat to make a profit.
Please note that most of our UK customers trade US stocks and options.
Of all the clients you have known what would you say is the main difference between clients that make money and lose money when trading online?
Clients who make money tend to do their homework.
They study companies whose stocks they trade. They often trade the stocks of two companies against each other as the relative prices fluctuate against each other.
We even built an algorithm for these customers, that we call the Scale Trader for Pairs.
IB has always offered discount brokerage. But, what do you make of the new breed of brokers offering share dealing for free? Do you think the underlying model is sustainable?
Yes, it is sustainable. There is no limit to the gullibility of people. They do not realize that they lose more money in the form of poor executions than their commission would be.
And finally, what would be your top three online resources that you could recommend to clients who want to improve their trading and investing?
I am not much of a believer in investment books.
I think people’s most valuable resource should be their own common sense.
In our everyday lives we are constantly surrounded by the products and services of publicly traded companies. Think about them, evaluate them against their competitors. Which ones are going to grow and which ones will shrink or disappear?
Read the research about the economy and about specific industries and companies.
Specialize. Become an expert at a small segment of the economy and trade the stocks and commodities relevant to your expertise.
Keep on top of events as they evolve and try to project forward.
Think about it every day.
When you are successful, it is a lot of fun, provides an income and helps the economy.
Note: Since this interview Thomas Peterffy is Interactive Brokers’ now Chairman and Milan Galik is CEO