A stock broker, or commonly called a brokerage, is a regulated business institution that provides the services needed to buy and sell financial securities between a buyer and a seller, which can be either institutions or private clients or even the brokerage itself. All trades conducted on the financial markets must be executed via a broker, so the broker basically facilitates all transactions the client places.
Brokers make their money by charging the client a commission. The commissions charged depend on what type of services the broker provides to its clients. It is important choosing the relevant broker you need for your type of trading. Generally speaking, the higher the service from the broker in terms of providing research etc the higher commissions they charge.
It is also important deciding the broker in accordance to what type of products you will trade. There are brokers specialising in options or other financial instruments. You can have several brokers as well. Maybe most of the business you conduct is dependant on low commissions but you also need a good options trading access, you can then have two accounts, one for the intense day trading and one for your options trades to be executed.
All brokers provide online trading systems. There is no best broker around, so it is vital deciding what types of trades you want to conduct, how intensely will you trade, do you need research, what kind of trading application do you prefer, will you trade on a computer or a mobile application etc?
Two types of brokers
The “full house”/traditional broker house is usually the broker that charges the highest commissions. This type of broker will have a research department with financial analyst providing specific research on specific companies, macro themes etc. You will get a dedicated person to talk to if you wish, your broker/salesperson, who will be able to execute orders for you (in case you don’t trade electronically), get you specific research, find liquidity in less liquid stocks, get you access to more products, provide opportunities to participate in IPOs and much more. Full house brokers usually provide services such as asset management, loans and other banking services. These firms tend to fit the longer term investor better since they charge relatively high commissions and usually offer less short term trading tools.
Discount brokers and online brokers are firms generally charging less commissions than the full house broker and they offer less personalized services. The client gets access to an online trading system and you will seldomly have a physical person as your broker. The discount brokers are usually good options for the less active day trader and the slightly longer term swing trader.
Online brokers, also called direct access brokers, are usually the preferred choice for the most active traders. They provide the best access to markets and they usually have the fastest trading systems. The trading platforms are usually rather sophisticated and provide you with possibilities to use execution algos, customise keys to trade predetermined size for example and other features interesting to the active trader. You can usually make a direct deal with these firms in accordance to how much you trade so the trading system is paid via commissions you produce. It is advisable to choose your broker and study what they offer properly before you start trading.
Commissions and fees
There are basically two structures for commissions. Either you can chose the per trade fixed commission or the per share commission.
The fixed option structure charges you a flat fee per trade (usually with a max trade size). Generally speaking this type of deals benefit larger trades only. The fills of your orders are less efficient since the executing broker usually routes the orders to a pre designated liquidity provider. The trader usually can’t reroute the orders to other ECNs or liquidity providers. Ceteris paribus the order gets fewer options to get good fills and this results often in less efficient order fills. Scaling back on orders, modifying orders etc will be much more expensive with the flat rate structure. In short the fixed structure favours the trader wanting to execute large trades and who is not overly concerned with having the best possible micro fills of the order.
The per share commission structure will charge you for the shares traded only. Your orders will mostly be routed to various liquidity providers, exchanges, dark pools etc. Usually the trader will be using the smart routing function which is basically an algorithm constantly sniffing where the best possible fill can be executed. Your orders will be more efficiently traded as liquidity will be greater. This fee structure is well suited for the active day trader that usually scales orders, fills the orders partially, trading larger orders in smaller increments etc. Very active traders usually negotiate special deals with brokers where you as a trader can expect either a very low commissions structure per trade, or that you have certain thresholds where you get a rebate when certain levels of commissions have been reached. Make sure to check if you are entitled to rebates if you as a trader provide liquidity, sitting on bid/offers and getting lifted or hit on those prices. The inverse is taking liquidity by buying on the offer or selling on the bid and this can incur extra costs to your trading.
Types of Orders
There are two main type of orders, market or limit order.
The market order will send your order to the market immediately and your order will get executed at the current price. If you want to sell a stock the order will hit the best bid price, if you wish to buy a stock, your order will lift the best offer in the market at this time.
Your order will be executed immediately, but you will not be guaranteed a certain price. Be aware that your order might be executed at a higher or lower price compared to the last price traded since the market moves constantly. Market orders are well suited for orders where the investor wants the order quickly executed. Market orders should be used in liquid names only since the spread between the bid/offer remains almost always small, but even liquid stocks can get less liquid in situations around news etc and your market order might end up getting a bad order fill. Novice traders can get unpleasant surprises when they send market orders around events, and get fills right at the time a spike/dip in a stock occurs.
A limit order is an order with a specified limit of a certain specified price to be used in order to execute the order. You can specify to buy a stock for example at 20 usd. You will buy the stock at a maximum price of 20 usd, but you will have the optionality to buy it for less should the stock already trade below 20 or if it starts trading below 20 at the time of you entering the order. The limit order guarantees you will buy the stock at a maximum price and you will hence not be a possible victim of spikes/drops in stock prices.
There are additional types of orders to consider. The stop order is designed to send the order when a certain price is hit. It is basically a dormant order that is inactive until a certain price is hit. When a certain price has been hit, the stop can be a buy or a sell order depending on your instructions, the order becomes live and you will buy or sell the stock at the market price. There are various algorithms to use where you can customize and put additional instructions how to execute an order when the stop limit has been hit. The simple stop limit order will send the order to be executed at the current market price. Say for example the stock falls sharply and hits the stop limit, then your order will get live and you will sell the stock immediately. If there has been negative news you might end up getting a bad fill due to liquidity immediately vanishing. You can add criterias to the stop limit order. One example is to use an algorithm that executes the order over the coming 30 minutes after the stop price has been hit.
Stop orders are good to use when you won’t be able to monitor the market but you wish to manage your positions.
All orders need to be specified in terms of time.
A day order (DAY) will be good for the day but will be cancelled automatically when the market closes that day (given it has not been executed). The day order time frame is usually the default setting at most brokers.
The good to cancelled order (GTC) will be live until you cancel the order manually. Brokers will many times have a max number of days limit on such orders, but the order is basically live every day until either filled or cancelled manually.
The fill or kill (FOK) order will execute the entire trade or it immediately gets cancelled. Say you see there are only 100 shares for sale in a stock but you wish to buy 1000 shares at a specific price. You can enter to buy 1000 shares at the price, if there are hidden sellers only showing 100 shares at the time you might get filled on your entire order, but if there were only 100 shares for sale you will not buy any shares and the order will automatically cancel itself. This is good practice to use especially in less liquid names where your order is relatively large for the market and you are happy to buy or sell relatively large orders but don’t wish to show your interest to the market.
There are many other order types and algorithms to use depending on the trading platform provided by your broker. A few more special orders are:
- Iceberg/hidden orders – your order will only show a fraction of your total size
- Conditional orders – you will apply “if/then” rational to your order, say for example if Apple hits a certain level and certain volume of shares trade then you will buy/sell the stock
- VWAP (volume weighted average price) – your order will be executed close to the VWAP price for a specific time period
- Market on Close – the order will be executed as close to the closing price as possible
There are many different conditions and algos to use and best is to decide what types of orders are important to your strategy and then see what the broker trading platform offers. It is important to keep it as simple as possible and not get too involved in using complex order types for the novice traders since they tend to partly confuse the trader.
There is a myriad of trading systems as well as information systems. Most brokers offer some sort of basic trading platforms as well as they usually have more advanced platforms for the more active traders. These are trading systems often developed by third party companies and white labelled to your broker. You download the software to your computer or mobile device easily and can execute orders as well manage your portfolio. The novice traders usually get by with the basic versions most brokers offer.
Generally speaking, the more advanced and active the trader the more sophisticated system they tend to use. Be sure to check out whether your broker can meet your needs. Systems are mostly evaluated in terms of: stability, reliability, speed, access to markets, support etc. Do you require advanced algo to execute your trades? WIll you trade a lot of options? How is the risk management tool? These questions are important to answer before deciding what system to choose. One important factor to check prior to any trading system decision is the support function. Do you get access to a good customer support?
In normal markets people don’t care about these aspects, but when markets get volatile and you have multiple orders in the market and the system experiences problems, you will be frustrated and could potentially lose substantial amounts just as an effect of not knowing what orders have been executed etc. Best is to have a hotline number to a physical broker/support that can quickly tell you what has been executed, they can withdraw/modify orders should the system experience a glitch. Glitches are unfortunately often experienced in volatile markets.
There are also external systems that are available to very active traders demanding advanced products. Such systems are usually relatively expensive but are in many cases necessary for the professional traders. Systems such as ORC software, MUREX etc are all advanced systems.
All systems have an order execution feature that enables the trader to execute orders. Most people need rather basic features only such as placing bid and offers and they don’t require advanced features, but there are various systems offering the client more advanced execution tools. Some systems allow the trader to program own instructions with regards to how they want the orders to be executed. Via API connectivity a trader can link various instruction to execute in the trading application. For example you might be trading statistical mean reversion strategies based on excel. These rules can be automatically executed via the trading system given the broker offers this type of system.
Majority of trading systems your broker will provide gives you access to basic views of your portfolio and some basic risk management tools. This is usually sufficient for basic trading, but the more complex your trading and portfolio develops the more you will need to look for an external risk management software. The advantage of such systems are the possibilities to view the portfolio from various points of risk as well as you can apply stress tests to the portfolio.
Trading platforms the broker provides will have some features with regards to news and market information. These feeds are usually rather basic. There are information systems such as Bloomberg, Reuters etc but these systems are relatively expensive. Usually you can add on extra news services such as news from Dow Jones etc to your trading platform. These costs will be taken out of your account. The internet is full of information but one needs to filter out the noise. AskBrokers.com will provide relevant information and market intelligence for free. For the more advanced traders you will also have a premium service where real traders provide the best insight and market intelligence available on the internet.
Scan for Stocks
Most platforms will give you some sort of possibilities to scan for stocks that can be potentially interesting to trade. The more advanced the system the more possibilities you can scan for specific criterias. Scans can range from basic concepts such as top gainers/losers to more advanced formulas where multiple conditions are to be met as criterias. Many times traders wish to add various technical analysis criterias to their scans. These can be based on criterias such as; stocks with RSI above below certain levels, moving averages crossing certain levels or multiple candlestick formations giving the trader possible trading setups. You can also scan for fundamental ratios of a company. Depending on the system you can choose to get various alerts when a stock matches your criteria.
There are many stock scanners available. Depending on preference you can have your own scanner via a system with many possibilities to customize the criterias. There are also several subscription based scanners that crunch for signals and present the results online. The more stocks and more scans the more computer power you will need. It is advisable to use a designated execution computer and not run heavy scans on your trading computer as it probably will slow down your system as you conduct the number crunching.
You can scan for stocks on criterias being; fundamental, technical, daily and even intra daily. One important factor in screening for stocks is that you can end up with many possible setups and get lost in information overflow. It is advisable to create a watch list, focus on a few sectors or other criterias that narrow down your searches. The more criterias you add the more refined your screening. Most short term traders get a feel for certain stocks and like trading these specific names.
Try to focus on quality scans over quantity scans irrespective if you chose to custom make your scans or use a subscription based product.
Bloomberg, although a relatively expensive system (basic subscription cost approx 2 000 usd per month), offers probably the most in depth information when it comes to practically anything financial market related. News, risk management, fundamental/technical analysis related, execution etc are all modules you can use in a Bloomberg terminal. Most traders will not need this type of exclusive system and can mostly rely on a good broker trading platform covering most of the needs.
Traders, both short term and longer term, tend to use charts in their trading. Even fundamental investors ask about chart levels. Depending on your demands charting stocks and looking at charts is probably one of the most important features of a traders’ day to day job. It is important to have a good feel about the charting possibilities you choose. Some traders work with many technical indicators such as RSI, MACD, Bollinger Bands etc and need to have these indicators in the charts section, others use less indicators but are very specific about the chart layouts etc. From personal experience traders tend to use many indicators when they are new to technical analysis and chart most of these, but after a while they tend to revert to a few favourite indicators and a few favourite setups they look for.