Market Spotlight: Volatility seen boosting retail brokers

"We're probably at the final phases of volatility being a positive," said Matt Snowling, an analyst with Friedman, Billings, Ramsey & Co.

Fees on customer trades are a large source of revenue and provide a wide profit margin for retail brokerage firms. The more active traders are, the better for the brokerage company's earnings.

"In the near term, it's a positive for online brokers," said Richard Repetto, an analyst with Sandler O'Neill & Partners LP. Customers typically complete more trades in a volatile market, Repetto added.

In fact, Charles Schwab Corp.'s earnings rose 12 percent to $305 million in the latest first quarter that included wild market swings and increased volatility.

There were multiple days during the period where the Standard & Poor's 500 index fell more than 2.5 percent and other days where it gained more than 3.5 percent.

Companies like Charles Schwab and TD Ameritrade Holding Corp. saw a surge in average daily trading volume in January. Even February volume was better than the year-ago period, although it slowed compared with January's performance.

Schwab's average daily trading volume jumped to 369,500 trades per day in January before receding to 289,400 in February. Despite the month-over-month decline, trading volume in February was still 5 percent better than a year earlier.

TD Ameritrade clients averaged about 284,000 trades per day in February, down from 346,000 in January, but better than the 264,000 averaged in February 2007.

The volume declines in February could be an indication brokerage firms are entering a prolonged slump in trading volume, which in turn would slow earnings. Analysts say volume could slow below year-ago levels in the coming months as customers move toward more conservative investments if the market remains volatile.

"Historically the short-term boost comes as customers tend to want to turn over their portfolios to safer stocks," said Patrick O'Shaughnessy, an analyst with Raymond James and Associates. Once that move is made, volume usually declines as customers become more conservative, he added.

If consumer confidence continues to dip due to recession fears and continued market volatility, O'Shaughnessy said trading volume declines will likely become noticeable within three months.

Aside from moving to safer stocks that would be held for longer terms, customers could also move into cash positions, Snowling said. Cash positions in accounts provide narrower profit margins for brokerages than margins on trading fees, further cutting into profits, he added.