1 AGENT-ALL FIG. 4
1 BID-TO-ASK RATIO: 4.8:1
72%
1
METHOD FOR MONITORING AND
TRADING STOCKS VIA THE INTERNET
DISPLAYING BID/ASK TRADE BARS
This invention relates to methods for dealing in the stock market and in particular to such methods involving the monitoring of stocks on the Internet.
BACKGROUND OF THE INVENTION
Investment Strategy
The best technique for making money in the stock market can be summed up in four small words: buy low, sell high. A successful investor is someone who can buy low and sell high enough so that he comes out ahead at the end of his transactions. There are three basic investment strategies to which investors commonly subscribe in their efforts to try to buy low, sell high: (1) pure fundamental analysis, (2) pure technical analysis, and (3) a combination of fundamental and technical analysis.
Fundamental Analysis Strategy
Otherwise known as the value method of investing, a fundamental analysis strategy is the investment in stocks on the basis of the value of the companies represented by the stocks. The company's balance sheet, income statement, and the like, are studied to help determine the financial and market position of the company. If the analysis of the company's historic growth and profit patterns show a steadily growing organization, and the research of the organization and its markets show a company that is competent and sound, a fundamental analysis approach should conclude that the company will continue to grow and prosper in the future.
Technical Analysis Strategy
The technical analysis strategy is a favorite of market timers. These are investors who try to make profits based on the short-term swings of the market. Market timers range from day traders, who try to take advantage of hourly or daily price changes to make a profit, to slightly longer-term investors who track stock price and trading volume fluctuations over a period of a few days or weeks and trade on the basis of recent trends. As opposed to fundamental analysis where the emphasis is on the strength of the underlying corporation, technical analysis focuses on patterns that appear on the historical price charts of a specific stock and of the stock market in general in order to help predict the future of that stock's price. This strategy is based on the theory that certain patterns of stock prices tend to repeat themselves over time.
Combination Fundamental and Technical Analysis
Strategy
A third investment strategy combines elements of both fundamental and technical analysis. An investor following this strategy will research companies until he finds one that he feels is competent, sound and looks like it will continue to prosper in the future. However, before buying stock in it, he will look at historic price charts to help him determine the best moment to buy. Based on the price chart, the investor may decide to wait a few days, weeks or months before buying the stock.
The Internet
The Internet is a large connection of interconnected computers. Initially developed by the United States Defense
2
Department, it has recently expanded to a great variety of uses and is growing rapidly. A significant percentage of the population in the United States and in many other countries currently has access to the Internet and uses it frequently.
5 Internet users continue to grow rapidly.
Many companies have web sites and encourage potential customers to visit these sites. Creation of web sites is a well-developed Internet business with many people and organizations offering to create web sites. In addition, many
1° books are available providing instructions for individuals to create their own web sites.
Web site owners use their web sites for varying purposes. Some of these purposes include advertising products or services, providing information, or for selling products or
15 services. More specifically, in recent years the Internet has become a major means by which investors and brokers can both monitor the stock market and buy and sell stocks.
How the Internet Helps the Investor
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Although an investor does not need to be online to buy stocks, the Internet can be of great value to him. The Internet offers resources that are unmatched by any single print source. A wired investor can get access to literally thousands 25 of investment services, publications, newsletters, and discussion groups from the comfort of his living room or office. In this manner an investor can quickly gather a large amount of information about companies in which he is interested.
The Agents
30 S
Market Makers, Specialists and Electronic
Communication Networks
Market makers, specialists and Electronic Communica35 tions Networks (ECNs) make market in stocks. Market makers are part of the National Association of Securities Dealers market (NASD), and specialists work on the New York Stock Exchange (NYSE) and other listed exchanges. An ECN is an electronic board where buy and sell orders 40 may be posted by any investor worldwide. These agents serve a similar function but there are a number of differences between them.
Specialists
45 The New York Stock Exchange (NYSE) is the oldest stock exchange in the United States. The NYSE (as well as the Philadelphia, Chicago, Boston, and Pacific Stock Exchanges) uses an agency auction market system that is designed to allow the public to meet the public as much as
50 possible. The majority of trading volume (approximately 90%) occurs with no intervention from the dealer. The responsibility of specialists is to make a fair and orderly market in the issues assigned to them. They must yield to public orders which means they may not trade for their own
55 account when there are public bids and offers better than their own. The specialist has an affirmative obligation to eliminate imbalances of supply and demand when they occur. Specialists are required to make a continuous market. The exchange has strict guidelines for trading depth and
go continuity that must be observed. Specialists are subject to fines and censures if they fail to perform this function. NYSE specialists have large capital requirements and are overseen by Market Surveillance at the NYSE.
A specialist will typically maintain a narrow spread
65 between offers to buy and offers to sell. Generally, the trader will need access to a professional's data feed before the trader can really see the size of the spread.
There are over a thousand NYSE members (i.e., seats), of which approximately a third are specialists. To date, there are over 3000 common and preferred stocks listed on the NYSE. On the average, each specialist handles 6 issues. The very big stocks will have a specialist devoted solely to them. 5
Every listed stock has one firm assigned to it on the floor. Most stocks are also listed on regional exchanges in San Francisco, Chicago, Philadelphia and Boston. All NYSE trading (approximately 80% of total volume) will occur at that post on the floor of the specialist assigned to it. 10
Market Makers
NASDAQ is an abbreviation for the National Association of Securities Dealers Automated Quotation system. The NASDAQ market is an interdealer market represented by over 600 securities dealers trading more than 15,000 different issues. These dealers are called market makers. Unlike the New York Stock Exchange (NYSE), the NASDAQ market does not operate as an auction market. Instead, market makers are expected to compete against each other by posting the best quotes (best bid, i.e., best offer to buy, and best ask, i.e., best offer to sell).
A NASDAQ Level II quotation system shows all the bid offers, ask offers, size of each offer (the order size), and the market makers making the offers. The order size is simply 2J the number of shares the market maker is prepared to fill at that price. Since about 1985 the average person has had access to Level II quotes.
The Small Order Execution System (SOES) was implemented by NASDAQ following the 1987 market crash. This 30 system is intended to help the small investor have his or her transactions executed without allowing market makers to take advantage of said small investor. The trader may see mention of "SOES Bandits" which is slang for people who day-trade stocks on the NASDAQ using the SOES, scalping 35 profits on the spreads.
A firm can become a market maker on NASDAQ by applying to NASD. The requirements include certain capital requirements, electronic interfaces, and a willingness to make a two-sided market. The trader must be there every 40 day. If the trader doesn't post continuous bids and offers every day the trader can be penalized and not allowed to make a market for a month. Market makers are regulated by the NASD, which is overseen by the SEC.
The brokerage firm can handle customer orders either as 45 a broker or as a dealer/principal. When the brokerage acts as a broker, it simply arranges the trade between buyer and seller, and charges a commission for its services. When the brokerage acts as a dealer/principal, it's either buying for or selling from its own account (to or from the customer), or 50 acting as a market maker. The customer is charged either a mark-up or a mark-down, depending on whether they are buying or selling. The brokerage is disallowed from charging both a mark-up (or mark-down) and a commission. Whether acting as a broker or as a dealer/principal, the 55 brokerage is required to disclose its role in the transaction. However, dealers/principals are not necessarily required to disclose the amount of the mark-up or mark-down, although most do this automatically on the confirmation as a matter of policy. Despite its role in the transaction, the firm must be 60 able to display that it made every effort to obtain the best posted price. Whenever there is a question about the execution price of a trade, it is usually best to ask the firm to produce a Time and Sales report, which will allow the customer to compare all execution prices with their own. 65
In NASDAQ, the public almost always meets the dealer making it nearly impossible to buy on the bid or sell on the
ask. Dealers can buy on the bid even though the public is bidding. Despite the requirement of making a market, in the case of market makers there is no one firm who has to take responsibility if trading is not fair or orderly, as what seemed to have happened during the crash of 1987. At that time, many NASD firms simply stopped making markets or answering phones until the dust settled.
Electronic Communication Networks
Recently, Electronic Communication Networks (ECN) were established in order to allow investors to trade NASDAQ listed stocks without having to go through market makers, oftentimes resulting in better fills for the investor. An ECN is an electronic board where buy and sell orders may be posted by any investor worldwide. The best bid and best ask orders from the ECN are posted in the NASDAQ system alongside those of market makers.
Bid, Ask, and Spread
If a trader wants to buy or sell a stock or other security in the open market, he normally trades via agents on the market scene who specialize in that particular security. These people stand ready to sell the trader a security for some asking price (the "ask") if the trader would like to buy it. Or, if the trader owns the security and would like to sell it, the agent will buy the security from the trader for the bid price (the "bid"). The difference between the best bid and the best ask is called the spread. Stocks that are heavily traded tend to have very narrow spreads (e.g., Vs of a point), but stocks that are lightly traded can have spreads that are significant, even as high as several dollars.
The width of the spread is indicative of the stock's liquidity. Liquidity basically measures the willingness of investors to buy or sell significant quantities of a security at any time. In the stock market, market makers or specialists (depending on the exchange) buy stocks from the public at the bid and sell stocks to the public at the ask (called "making a market in the stock"). At most times (unless the market is crashing, etc.) these people stand ready to make a market in most stocks and often in substantial quantities, thereby maintaining market liquidity.
Dealers make their living by taking a large part of the spread on each transaction—they normally are not long-term investors. In fact, they work a lot like the local supermarket, raising and lowering prices on their inventory as the market moves, and making a few cents here and there.
Online Trading Over the Internet
There are two types of online trading available to the public. The first type is Internet trading provided by firms that route the trader's order to a trading desk or to a third party willing to pay for order flow. The other type of Internet trading is a dedicated online service provided by firms where orders go directly to the exchange yielding a quick and efficient execution.
The Data
If the online investor is of the first type discussed above, his order may be gamed by a specialist or market maker handling the order. Unfortunately, if this happens to the trader, he will not recognize it from the minimal information provided in the order confirmation. At best, he knows only what's called Level I data—the best bid, the best ask, the last trade, and the order size of each data respectively.
If the trader is of the second type (i.e., his order goes from the firm directly to the exchange), the trader most likely is
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