If you want to do any trading or investing, you will need to open an account with a broker. There can be significant differences between brokers in terms of services offered as well as cost, so it pays to know what to watch out for.
Before the Internet, most brokers were full-service brokers who, as the name suggests, would pride themselves on their ability to give you expert advice and research, in addition to fulfilling your orders for you. However, as brokers are paid when you trade, this could result in a conflict of interest. The broker could recommend trading more than necessary, called “churning” your account, and might have other sources of income from making particular recommendations.
The growth of the Internet has been accompanied by a proliferation of online brokers, generally offering much cheaper trading costs. If you take control of your own investing, there is little reason to pay the price for a full-service broker anymore, as online brokers usually give access to as much information as you need and offer virtually instantaneous trading.
Even then, all online brokers are not created equal, and you need to do your homework to get the best deal. Trading online is simple and, because of the competition, inexpensive for retail investors
The most obvious cost of trading, the commission per trade, is often less than $10 with large online brokers such as Think or Swim by TD Ameritrade, Trade Station, Scottrade, and E*TRADE. There is a second less obvious cost that arises because of the “spread”, the difference between prices quoted for buying and selling. The larger the gap between these prices, the more you lose to the broker when you close your trade.
These are the two basic sources of revenue for your broker or dealer. There is a third cost for the trade, and this is a charge to your broker from the Securities and Exchange Commission (SEC) based on the dollar volume sold. As such, it is included in the money your broker receives from you from the first two methods.
In addition, some brokerages make money by “payment for order flow.” This is when the market makers, the professional traders who maintain a market in the stocks they represent, pay the broker to give them the trade rather than routing it through to others. Some brokers will allow you to override this, so it is worth asking.
There may be other costs, but often they are for optional extras that you may or may not need for your style of trading. You can pay a subscription for what is called Level II access to the markets, which is a detailed screen showing all pending orders in real-time. You can choose to buy or license a charting program and this may also involve paying extra for an up-to-the-second data feed of prices. Before committing to this expenditure you should check out the facilities offered by the different brokers you are considering, as their free charting may have all the analytical tools you need.
There are a number of details to look at before making a decision on the broker to use. The costs and charges are the most obvious, but there are other aspects that can affect your trading and profitability.
The quality of the trading platform is important. This covers various aspects, such as ease of use and the ability to select the chart indicators you want. Most brokers offer a demonstration account that allows you to practice trading without risking any money, so you can test out their interface. Given a good quality Internet connection, it is unlikely that you will see much difference in the speed of trading execution between brokers, as most trading takes place automatically. The speed at which you can place or close a trade is more likely to affect the outcome.
In case you have a problem with your computer or Internet, it is important to know that the broker can be contacted by telephone so that you can close any open positions or take other actions as necessary. It is worth testing the responsiveness of customer support before committing your funds.
In case of trouble, you should make sure that your broker is registered with the appropriate authorities. While this will not prevent problems, it gives you some assurance of a straightforward legal recourse if these arise. With the availability of the World Wide Web, it may not be obvious if the broker is resident in some tax-advantaged country rather than in your home state, but it will make a difference in pursuing any claims.