How to find your online broker
"Stockbrokers aren't too interested in a stock you can sit there for five years with."
Walter Schloss, Value Investor and Fund manager who was mentioned by Warren Buffet in his essay “The Superinvestors of Graham-and-Doddsville”
The term "online brokerage" basically means buying, selling and managing securities over the Internet. A brokerage enables you to buy stocks, bonds, mutual funds and other assets with money you deposit in your account. There is a range of brokerage firms from pricier full-service stockbrokers to low-fee online discount brokers where individuals can set up an investment account.
Table of Contents
Why do I need an online broker?
Brokers have the license to buy and sell stocks and other securities through an exchange. A broker can be trading on the trading floor, by phone or electronically. Stock exchanges can be found in most major countries with more or less open markets. However, their importance depends on the strengths of the respective economies in their countries. Major exchanges are:
- The New York Stock Exchange, which trades stocks auction-style on a trading floor in the USA
- The NASDAQ, an electronic stock exchange in the USA
- The London Stock Exchange, one of Europe’s biggest stock exchanges
- The Frankfurt stock exchange, the biggest German stock exchange
- The Tokyo Stock Exchange, the biggest Japanese stock exchange
- A comprehensive list of exchanges around the globe can be found here.
In an exchange buy and sell orders are matched and the price is determined by offer and demand. Stocks listed at an exchange have to fulfill certain requirements. Companies that do not fulfill these requirements are traded Over-the-counter (OTC). Usually these are smaller and more risky companies that are traded by experts. Most private investors use an online broker instead of a human broker, nowadays. Through the online broker, you can submit your trading orders directly via a secure website or via a separate brokerage software. The online broker then places the order to buy or sell the securities. If this succeeds, the respective security will be booked in the account of the customer (on purchase) or delisted (on sale). Online brokers usually do not offer advice as they are responsible for trading only. This means that inexperienced investors must be well aware of the risks of trading single stocks. They might look into advice or ETFs or other funds where the risk is distributed among several stocks. Many banks also offer online brokerage so that you can buy or sell stocks and other securities, but also have a checking or money market account at the same company. However, there are also pure online brokers, which offer only online brokerage.
How do I choose an online broker?
When choosing an online broker there are several aspects to consider: Assets/securities that you can invest in: Brokers offer different investment options: individual stocks, options, mutual funds, ETFs (exchange-traded funds), and bonds. More options make it easier to diversify your portfolio to decrease risks. Some will also offer access to futures trading and forex (currency) trading. Consider which assets you want to invest in.
- Commissions: Depending on the assets/securities you invest in, consider the commissions the broker charges for each category.
- Account minimums: some brokers require a minimum initial investment of $500 or more.
- Account fees: Usually brokers charge a fee for transferring money out of the account. Other fees might include annual fees, inactivity fees or charges for research or data.
- Guidance Needed: Beginner investors usually look for education and instructions on how to trade, e.g. include videos and tutorials.
- Technical capabilities of platform: Advanced traders usually look for analysis tools, research and data offerings and maybe also the possibility of higher-frequency trading.
- Promotions: Online brokers often offer commission-free trades or a cash bonus for new customers. A promotion may influence you when you’re stuck between two options. However, you should look at the bigger picture. The benefits of a promotional offer may be offset by higher commissions and account fees.
- Customer Service: Think for yourself which kind of customer service you need. Look at the various forms of support available, such as live chat, telephone support, email, etc. Discount brokers may not offer the best customer service. Also research online reviews of online brokers and see how they performed in the past.
- Other Services offered by Online Brokers: Some brokers belong to banks and offer other financial services such as checking accounts and credit cards.
What are the advantages and disadvantages of online brokerage?
Online brokers come with certain advantages and disadvantages. Advantages:
- You can trade from home or work or anywhere.
- Trading fees (especially at discount brokers) are cheap.
- Access is Quick and flexible and also possible at non-business hours.
- You have to adjust (buy and sell) your portfolio manually, in contrast to robo-advisors. Therefore, it is cheaper.
- You do not get any advice but are responsible for your own decisions. This also means you need to gain certain knowledge.
How much does online trading cost and how is it taxed?
The most common fees online brokers charge are:
- Account maintenance or inactivity fees: annual fees can range from $20 to $50, meanwhile many online brokers only charge them when you fall below a certain amount in your account or you are not trading at all.
- Trading fees are charged on every trade made.
- Fees for advice: In case you need personal advice from the broker this will be charged directly as a service or as a higher fee of the purchase.
- Margin: Margin brokers lend money to the clients which they can use for trading. The broker will charge interest on the amount loaned.
- Withdrawal fees: Some brokers ask for fees when cash is withdrawn from the account.
The respective trading fees depend on the instruments that you trade:
- Individual stocks: typically pay a per-trade commission of $4 to $7. Some brokerages offer per-share pricing.
- Options: Options trades usually consist of the stock trade commission fee plus a per-contract fee, which usually runs $0.15 to $1.50.
- Mutual funds: The mutual fund itself has some management fees as long as you own them. However, the online broker might charge you for buying a mutual fund as well.
- ETFs: ETFs trade like a stock and therefore are often subject to the broker’s stock trade commission. However, many brokers offer certain commission-free ETFs.
- Bonds: You can purchase bonds from the secondary market on the broker. This is easy but the broker might charge commission fees. Another option is to buy ETFs. Government bonds can be bought directly from the government but you will have to create an extra account.
The brokerage executes the orders but the assets belong to the investor. The investor must claim any capital gains incurred from the account as taxable income. Usually these gains are taxed when the profit is realized, meaning as long as you don’t sell it, it won’t be taxed. Investments that are held for more than one year qualify for long-term capital gains tax rate, which is lower than most tax rates.
How to set rules in online trading
Online brokers usually offer options to prevent high losses when a stock price is falling. These include:
- Stop order: A sale is executed after the price falls through a price that you set. It is important to understand that the asset will be put on sale at this moment. However, the order executes at market price, not at the stop point. In a crash where everybody is selling the price that you get might drop well below the stop point.
- Stop-limit order: A stop-limit order requires you to set a stop which indicates at which the asset will be put on sale. The limit indicates the outside of the price target for the trade. Furthermore, a timeframe must be set, during which the stop-limit order is considered executable. However, the trade is not guaranteed to be executed when the price falls quickly and it wasn’t sold.
- Trailing stop order: A trailing stop executes when the price falls through a point you set. However, this price is a percentage of the value it reached before and not a fixed amount, therefore this point is trailing the price of the asset.
How to start?
Many online brokers offer online test accounts where you can learn to use the broker and get a feeling for investing without putting your real money. Also, there are many competitions out there, where you can invest with virtual money. To get an overview of the possible online brokers you can use, many websites offer comparisons for online brokers:
- Overview on Broker with best brokers in general, best brokers for beginners and best brokers for options for the US at the Motley Fool.
- Overview on brokers at stockbrokers.com.
The cheapest way to invest is through online brokers. However, you need a certain degree of confidence to make your investments. You have to take your own decisions. However, many brokers offer help. To decide which broker is best for you should take into account different criteria like commissions, annual fees, services offered or assets that you can purchase on the respective platform.