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 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 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:
Why Choose Online Discount 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 investors
or traders who will choose to use an online discount broker. The main feature that active traders especially look for is direct access to the trading exchanges, without their order going through a market maker. 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 for index futures like the hugely popular E-mini S&P 500 Index Futures contract (symbol ES).
*** Important - How to Compare Different Commission Rates. Is Cheap, Really Cheap?
 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 an online discount broker who 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 who 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 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.
Continue to Part 2 - Tips on Choosing an Online Discount Broker
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