Trading For Dummies. Lita Epstein
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make trades electronically, so you never need to speak with a human being for these processes unless you’re having a technical problem.
The differences among brokers are based on prices, services, and special capabilities. High‐volume swing traders and day traders typically require the services of a direct‐access broker, while position traders can and do trade successfully with more traditional discount, online, and full‐service brokers. In this chapter, we help you understand the brokerage options that are available, the types of accounts you can establish, and the basic trading rules you must follow.
Why You Need a Broker
Unless you plan to get your brokerage license from the National Association of Securities Dealers (NASD) and set up shop yourself (which is hard – and expensive – to do), you need to work with a broker to be able to buy and sell stocks. How you choose a broker is based on the level of individual services you want. The more services you want, the more you pay for your ability to trade.
As an individual, you can open your account with a brokerage house, but if you work with a human being, that person is considered a broker. Brokerage houses or brokerage services are also usually referred to as brokers for short.
Exploring Types of Brokers and Brokerage Services
Before you can pick the type of broker that best fulfills your needs, you need to understand the kinds of services that each kind of broker provides. After you gain an understanding of your options and select the types of services you want, you then need to carefully research each of the brokers that match your needs. Within each classification are good and bad brokers. We give you the tools for researching brokerage firms in the sections that follow.
If you want someone to assist you with buying decisions and implementing those decisions, you need to check out full‐service brokers. They offer extensive research and other services. Usually, they call you with trading ideas. All you need to do is say yes or no. You pay a transaction fee for trades plus a commission percentage based on the dollar volume. You can invest in stocks, futures, options, bonds, mutual funds, money‐market funds, and variable annuities. You can work with a full‐service broker by telephone, mail, fax, or Internet. Most have websites you can access for information, and many allow you to enter your own trades.
Here is an example transaction fee schedule for one of the better‐known full‐service brokers (others can be as much as twice as high):
Alternatively, some full‐service brokers do permit you to make all the trades you want per year for a fee of 0.30 percent to 2.5 percent of the total assets in your brokerage account. Using language common to traders, that’s 30 to 250 basis points. You have to have more than $10 million in an account to get the lowest fee. Traders with less than $100,000 pay closer to the 2.5 percent of assets to access the unlimited trading features.
Even the research arms of many full‐service brokerage houses are scrutinized by the Securities and Exchange Commission (SEC) primarily because their analyses didn’t accurately reflect the values of stocks in companies that used the firms’ investment‐banking capabilities in the past. Analysts tend to see their firms’ clients through rose‐colored glasses when providing research reports, especially when their firms make a lot of money by providing investment‐banking services to those companies. We talk about changes that have been implemented to improve analyst services in Chapter 7.
Many discount brokers offer the same services as full‐service brokers, including research. The big exception is that you don’t get individual attention or unsolicited advice on what to buy or sell. Some discount brokers send out monthly newsletters with stock recommendations; most don’t trade futures or sell variable annuities. You can access a discount broker by telephone, mail, fax, or Internet. To get the lowest fees on trades, you need to do your own trades by accessing the broker’s website.
The big difference to you, as an individual trader, is that you can save a lot of money on trading costs, provided you know what you’re doing and you understand the language of stock trading. Transaction fees for online trades can range from as low as $5 up to about $30 with a discount broker. If you want special services requiring a broker’s assistance, you can work with a human being. Depending on the discount brokerage firm and the level of service required, fees can range from $25 to $50 per trade. Some discount brokers provide broker‐assisted trades using a commission rate schedule similar to the ones offered by full‐service brokers, but it has lower fees per trade. If you get involved in more‐complicated trading transactions that require human assistance, costs can rise significantly. Anytime you’re planning to use a broker’s assistance, be sure you understand any additional costs that may be charged to your account for that assistance.
If you want to bypass the traditional brokers and trade directly through an exchange or market maker, you need to open your account with a direct‐access broker so you can use one or more of the electronic communications networks (ECNs) to make your trades. Traders usually download software onto their PCs so they can access the ECN directly using their Internet connections.
Traders using direct‐access brokers typically get real‐time NASDAQ Level I quotes, which show the latest bid and ask prices, quote size, last trade, and volume.
Direct‐access brokers also offer NASDAQ Level II access. NASDAQ fees are higher for Level II, and the brokerage may also charge an additional fee for this type of access. In addition to what you see in a Level I quote, you also find the number of market makers participating in the market for any one stock.
A NASDAQ Level II quote screen shows the best bid price and the best ask price for specific stocks from participating market makers. All the bid and ask prices are ranked from best to worst. Some direct‐access brokers combine NASDAQ Level II information and ECN book data to show the complete market depth for a specific stock. The ECN book isn’t a printed book like you would expect to find on a bookstore shelf. It’s a compilation of all the trades and the bid and ask quotes available on all the electronic networks.
Traders