Choosing the Right Online Broker
Trading is a Serious Business
Far too often, I see alleged “professional traders” gloating about massive wins and seldom mentioning the most fundamental truth about the game, the ultimate red pill all traders should swallow early is – trading is a business! I actually follow an hilarious twitter feed that trolls supposed ‘Trading Gurus’, I highly suggest following Guruleaks as he calls all these charlatans out on twitter.
Not only is trading a business, but it is a business like no other which gives unparalleled rewards to those who can figure out the personal puzzle and punishes those who fail to assess the risks appropriately or take personal responsibility.
Choosing the right online broker is a critical step in building a trading business, make the wrong choice and it could wipe you out.
Subtle and Obvious Trading Costs
Prospective traders or investors have a multitude of decisions to make before the act of buying and selling takes place, such as:
- Which online broker or brokerage firm to use
- Newsletters or mentors to sign up with (I suggest none to start)
- Required charting or technical analysis software
- Does their trading style or strategy require data such as level II or live data – which can be an additional cost
- Opportunity cost in pursuing a career that involves less introspection and time
One of the most fundamental flaws in trading systems or styles, is the amount of brokerage fees and additional costs incurred by the system are swept under the rug. People focus on the raw numbers (win/loss and risk/reward) and don’t count commissions and subscriptions as part of their overall return. The result: Traders or investors become drunk with delusion about their trading results but could in reality be hemorrhaging capital. Everything has a price, trading is no different.
Choosing an online brokerage firm should be the same as renting or leasing a premises. The decision should be made on very specific criteria aligned with your goals and aspirations.
Trading Costs Money
Surprise! To make money on the stock market, sometimes you need to spend money. Who would have thought? Here I was thinking that stock brokers and brokerage firms were giving me hundreds of buy and sell signals because they care about me. It couldn’t be that they wanted me to be overly active in the market for them to profit could… could it? Surely that nice sales agent on the phone works for free as opposed to having sales targets and quotas to fill!
I hope my sarcasm leaped out of the page here. Brokerages and the financial media are all about getting you hot and bothered to jump in and out of the market like a kangaroo on cocaine. Every time you do that, they will charge you for the supposed privilege. You will be treated like royalty and have access to data, reports, analysis and all kinds of dressage that lures you into thinking that Buffet should step aside as “you have arrived!”
See through the charade for what it is – good marketing from multi-billion dollar companies. They can afford to hire the best in the business to make you believe almost anything.
Evaluate Your Broker
All brokers are not made equal though, I found this out the hard way in 2014 when I won over 80% of my trades, managed my risk/reward ratio and returned 14% – as opposed to the 57% I would have made in the same year. I had to double take the realized P/L at the end of my statement. Surely this could not be true! (it was).
Please heed the warning, think before you click, it could be the difference between financial freedom and working that 9 to 5 until 65.
There are some websites dedicated to solely reviewing brokerage firms, I would highly suggest looking at a few articles and the website itself to make this evaluation. Always cross reference these with other reviews and consider the following:
- Costs per trade
- Cost of live data (if you need it)
- What markets you can access
- Maintenance costs
- Years in business – I am very shy of putting large capital with a new company
- The trading platform itself
- User experience
- Location and accessibility
Try them out and don’t commit until you are confident in your decision.
There are of course a number of other factors but these should be a good start. Usually there is a compromise between cost and quality. If something seems too good to be true, it probably is. You may sacrifice trade execution or user experience for highly discounted brokers – to me, that’s okay in some cases. I just want a brokerage that will execute my trades at high speed and not kill me with fees.
In my personal opinion I get fast, reliable, inexpensive and high quality trading options from Interactive Brokers, I switched from TD – Ameritrade and never looked back (I’m not being paid to say this in case you are wondering). New traders however could simply click the wrong button and get an order filled at 10X off the bid if they move a decimal one place too far – it’s all relative.
Needless to say, my shift to a new broker was warranted. After a review of years of trading data I calculated the gap that commissions made on my overall returns. The combination of over trading and high fees cost me well in excess of $9k! Everything is clear in hindsight, some quick lessons on the matter:
- Keep close tabs on trading fees before u go bananas with trading
- Check your statements for hidden fees
- Ensure that trading data is relevant and inexpensive
After so many years of building up my wealth, it was shocking to admit how little money I was being left with at the end of the year. Another reason that trading reviews or good journals are so powerful in showing you gaps in your trading business.
Win Small or Lose it All
To further prove out this fact I took a look at my trading stats (# of trades) and applied this to the arbitrary figure of 10% per year (that some people would be happy to get). I then removed fees and got an approximation of the average annual return using various brokerage houses. Some caveats before I’m torn to shreds:
- I know commissions can go down after more trades using volume discounting
- Pricing on TD has gone down since I took the pricing from their site to $6.95
- The other 1000 things that don’t really matter – the foundations remain the same
As you can see from the above results. If you live in Ireland (I do) you may need to re-asses your trading career. Not only will you be punished with your obligatory 33% capital gains tax but the brokerage firms run a pretty sweet monopoly here for the uninformed. Notwithstanding – if your a day trader you could be stung for 50% of your gains too if you’re any good.
Far too few investors or traders assess these costs which is counter-intuitive. The entire point of investing is to be rewarded for financial wisdom. The numbers however need to add up.
Just as compound interest works in our favor over time, the same compound interest works against us with high fees. When putting together the numbers I had to double take at the sheer insanity of it all. Basically, choosing the wrong broker can not only eat into your profits but ruin your trading account and totally wipe you out! This isn’t even factoring in the inherent market risk associated with active trading.
Although fees and commissions are important, brokerages- like any other business costs, should not be assessed in a vacuum. Some brokerage firms may charge a premium but offer some great features like:
- Trading education
- A high quality charting and trading platform
- Higher levels of customer service and satisfaction
One of the many joys of trading is that nobody is going to tell you what to do. You are free to make your own decisions.
As traders, we need to be in and out of the market at a moments notice. Trading with high fees destroys your edge and puts more pressure on your trading account than necessary. I have a very difficult time justifying $9.99 trades even on my retirement account, paying them as an active trader is commercial suicide.
There are also however some downsides to low fees. They may seem a bit strange but when reading my trading diary last year the same theme kept popping up. The following issues were prevalant in my trading journal as a result of switching:
- Impulse trades
- A strange one: slipping discipline
I genuinely think that knowing you can enter and exit a trade for less than a cup of coffee gives you a false bravado that makes it far too easy to trade. I’ve had to tone it down and try to really focus on my setups and not be lured into the cheap trap. Just because trading can be inexpensive on the surface, does not give you a license to switch your arsenal to fully automatic and unload clip after clip of impulse trades. I’ve been there, I don’t plan on going back.
- If you are new to trading – take your time before getting in a long term relationship, try a few platforms out before getting in bed with one for life.
- Use a few – you can split up accounts and use the data from one to trade on another, be flexible in how you manage your money.
- Beware of marketers and scams – if it sounds too good to be true, it usually is.
- Don’t put all your eggs in one basket – if your broker goes down, even for a minute, always have backup.
I hope you’ve found this blog useful. To iterate, I stick with Interactive Brokers because they have been really good to me. I also use TC 2000 for my charting. If you think there are better options out there, get in touch and I’ll look into it!