Resistance Is Futile: TradeStation Succumbs to Forex Appeal

Originally posted on April 11, 2011 at the Aite Group Blog

Active trader darling TradeStation (NASDAQ: TRAD) announced today the launch of its TradeStation Forex Inc. subsidiary. Its arrival to Forex continues to solidify the arrival of well-capitalized financial firms into a space dominated by brokers that only offer FX services to a retail public: Deutsche Bank (DBFX, 2006), Citibank (CitiFX Pro, 2007), and TD Ameritrade (thinkorswim, 2009). Interactive Brokers (IB) and Man Financial have offered retail FX since at least 2005, but neither has created a separate entity for it or promoted it actively.

A little perspective about this move by TradeStation is in order. The firm debuted in 1982 at the onset of the trading software revolution, and went public in 1997. TradeStation launched its brokerage business

almost 10 years ago this month, and has made it the engine of its steady growth. Although a small to midsize securities firm in the market today (US$294 million market cap), TradeStation has achieved a sizeable and stable presence within equity and futures active trading circles.

TradeStation has offered Forex trading through a fully disclosed partnership through Gain Capital (NYSE: GCAP) for several years now. But there are signs that the relationship has stopped working. TradeStation has long depended on a combination of subscription revenue for the software plus a competitive commission on the execution side. Gain covered the cost of the monthly subscription of TradeStation users, but charged larger-than-average spreads. A large regulatory fine to Gain Capital last year over execution irregularities was perhaps the final straw for the TradeStation-Gain relationship.

Why bother to track this latest press release? Several aspects of it are noteworthy:

TradeStation Forex (TSFX) is the first securities firm to create a separate division to promote retail FX. This recognition by a sizeable player suggests that Forex trading should no longer be considered an add-on product.  Also, TradeStation has not launched business units for equities or futures traders, even though they represent more than 90% of its 47,500 client base.

TSFX is the first of securities firms to launch its business as a Retail Foreign Exchange Dealer (RFED), regulated by the National Futures Association and Commodity Futures Exchange Commission. Prior financial firms have kept their regulatory status under the SEC or the Fed. Being a RFED requires a substantial capital commitment of US$20 million-plus just to play ball.

The TSFX offering brings to market a very interesting challenge to the MT4 trading platform dominance. The TradeStation platform is very superior to MT4 in terms of back-testing strategies and technical analysis tools for active traders.

The TSFX trade execution engine and pricing will no doubt be very competitive. TSFX has adopted an agency model with liquidity from Currenex, the well-known ECN provider. The spread markup the firm has in mind (Currenex spread +/- 0.5 pip) brings it into line with its successful tradition as a low-cost alternative for active traders.

TSFX will waive the monthly fee of its popular trading to retail FX traders. This is a major departure from the core principle of TradeStation’s as a software firm. The TradeStation Group is now is placing a well-grounded bet that its Forex division will more than make up the difference through brokerage revenues. This decision is based on the fact that active FX traders turn their accounts over many more times than do equities or futures traders.

The TradeStation software is at a point in its lifecycle where it will not likely grow fast among stock and futures traders, so the decision to venture into a new, fast-growing market makes sense.

TSFX will not start its business operations from zero, like any other startup RFED would. It counts on a few-thousand accounts from its partnership with Gain, and will endeavor to convert some of its 47,000-plus faithful equity and futures account holders into FX traders.

Perhaps more importantly, TSFX will be an important benchmark going forward for the potential revenue produced by active FX traders worldwide.

TradeStation Forex is off to the races in a very competitive market, with established players. But it goes with a powerful trading technology, established business presence, and attractive trading terms that will be a force to be reckoned with.