6 Tips Every Trader Should Know About Online Brokers
How can Online Discount Brokers like TD Ameritrade, Scottrade, E*TRADE and Interactive Brokers offer such inexpensive commission rates and still stay financially viable? Well, unlike their full-service counterparts, most discount stock brokers and futures brokers have done away with sizable research departments and don't offer any stock investment or other financial advice. They have essentially unbundled the traditional brokerage services which would have increased their manpower and other operating costs significantly.
There are two categories of online discount brokers, namely the "standard discounters", who charge commissions which are at least 50% less as compared to the full-service brokers, and the "deep discounters", whose commissions are almost 60-90% below those of the full-service brokers.
Here are some factors that active traders and investors consider when choosing an online discount brokerage firm:
1. Why Choose Online Discount Stock Brokers? Speed, Direct Access, Order Routing...?
More experienced traders and investors have had enough exposure to the stock markets and other financial markets to know their trading and investing needs well. Most of them are primarily interested in quick and reliable service rather than paying for full broker services which they may not use at all. These are the type of people who will choose the to use the services of an online discount broker. The main feature that active stock traders look for is direct access to the trading exchanges, without their order going through a middle-man or 3rd party. The advantages are faster response times, the ability to trade virtually at anytime as long as there are bids and offers in the market place, control over where their order is routed through (see Order Routing) and possibly liquidity rebates. In the US, most online brokers nowadays offer direct access to the NASDAQ, NYSE and AMEX exchanges for stocks and to GLOBEX, NYBOT or ECBOT for index futures like the hugely popular E-mini S&P 500 Index Futures contract (symbol ES), Russell 2000 e-mini (symbol TF) and the Dow Jones mini futures (symbol YM).
2. How to Compare Different Commission Rates. Are Cheap Rates, Really Cheap Overall?
While comparing and choosing a discount broker solely on lowest commission rates may appear to be very tempting, it would serve you to understand that this may not be the best option for you as your needs may not be in line with what the broker is offering. Different brokers charge commissions differently so a cursory broker comparison just based on price may not reveal the whole story. This is best illustrated with an example:
Low Volume, High Frequency Trader
If you are a low volume trader who trades frequently (lets say 100 shares, 5 times a week) and you choose a broker that charges a flat minimum commission of $9.95 for trades of up to 5000 shares, your commissions on your 5 separate trades are going to cost you almost fifty bucks (100 shares at $9.95 x 5 trades)! Compare this to an online discount broker that charges 1 cent per share, which would bring the cost of commissions of your 5 separate trades to only about 5 bucks (100 shares x $0.01 x 5 trades).
High Volume, Low Frequency Trader
On the other hand, if you trade less frequently but with size, (lets say 5000 shares a time at one go), then going with the first broker will make sense as it will cost you only $9.95 for buying the whole 5000 shares in one trade as compared to fifty bucks with the second broker (5000 shares x $0.01) for the same trade.
Can you see the difference in commissions paid if you do not choose your broker carefully based on your frequency of trades executed? In essence, if you trade more frequently, it is better to go with a broker who charges on a per share basis, like Interactive Brokers. On the other hand, a flat rate commission broker like TD Ameritrade will be more cost effective if you trade less frequently but with size.
Proceed to Part 2