START TRADING 101 | Lesson 7
How to Find an Online Broker that Matches Your Trading Style (and Pocket)
Congratulations for having come this far!
Your trading system should be ready for making your first trades – but now you will need an account with a brokerage firm to do so.
15 years back that was not as easy as it is today, so consider yourself lucky. There are many well established and reliable online brokers available today, and signing up is relatively straight forward.
The times of making frantic phone calls to reach your personal broker are over – making trades electronically from your computer, or even your smartphone application is very easy.
In this lesson, I will introduce you to the world of online brokerages.
This is not a detailed review of each, but I will provide you with additional resources at the end of this lesson if you want to read up more.
Not all brokerage firms are alike
Not too long ago, I received a phone call from a certain country in Asia.
A lady wanted to verify that my mailing address was still correct as per her information. She wanted to send me a brochure of an “extremely prestigious Wealth Management Firm”.
The whole approach appeared suspicious.
A wealth management firm cold calling me from outside my country of residence? How did they get my contact information in the first place (I was in my office in Dubai at that point)?
I strongly suspected that something was dodgy here… but I was curious and wanted to see how they would pull it off. So, I confirmed my address and waited.
Sure enough, after a couple of weeks, I received an envelope. Heavy, smooth paper.
Inside was a very shiny, beautiful brochure, explaining to me in detail how fabulously rich I would become if I just invested a little with this wealth management firm – eligible customers and limited availability only!
It looked the part… like a brochure from a law firm that has been around for more than 100 years. Someone worked hard here 🙂
My first thought when I saw that brochure was:
If you did not see that movie… go and watch it.
I was 99% sure this was a scam, so I dumped the brochure in the bin and decided to get on with things.
But the story did not end here!
Another two weeks later I received another call. A guy in a rumbling, deep and serious voice asked me if I received the brochure of his (prestigious) firm.
I said, yes, I did.
He then started up his sales speech, which at some point I interrupted, telling him that I would not need his services and that I was trading stocks myself… as per typical boiler room strategy, he turned the page and asked how much money I made from trading last year.
I said, “around 10%”. And with the smuggest voice you can imagine (he could smell triumph, maybe), he said “well, last year was not so great as we made ONLY 65%…”.
At that point, I did two things.
First, I hung up the phone.
Second, I was wondering, what would I do if I made 65% or more every year?
(For reference, Warren Buffett, probably the most successful stock investor in the world over the last 52 years, makes on average 20.8% yearly return, resulting in a net worth of 75 billion!).
Would I send shiny brochures and cold call people from overseas?
Nope… I don’t think I would.
This guy called me several more times… really insisting. If things are too good to be true… then they probably are!
Don’t fall for such “wealth management” stuff… the only people who become rich here are the company owners. Do you think Warren Buffet has a wealth manager?
Think about it.
Stick to established online brokers
I guess what I want to drive home here is that if you came this far in this course you already know that you will not need “expert advice”.
Brokers usually provide two things:
1) They facilitate your deals and trades, be it stocks, real estate or whatever else
2) They provide advice
Brokerages usually provide both… for more or less hefty fees.
Now, don’t get me wrong here. It’s absolutely OK to pay for expert advice… as long as it is for your benefit.
Unfortunately, in the world of finance, track records mean much less than they do with dentists and carpenters… because the latter are working in an environment that is much less affected by random events.
Read my post about Mutual Funds and MSAs if you want to know more about fees related to financial advice.
For now, just make sure you don’t fall for a no-name wealth firm that looks shiny but has nothing to offer.
Choose an online brokerage from a list of established companies that have a large customer base, and keep in mind that you should not need to pay for advice. Your trading system does all that stuff for you already.
Online brokers and their software
Most established online brokerages have their own trading software.
Some use a simple web interface, others a more sophisticated one. Then they often have software to download that you can run on your computer.
Most of them also offer a smartphone app. Others offer ONLY an app and not much else.So, there are a lot of choices. And each choice has many different features.
Most of such software has features like:
- Creating orders
- Technical Analysis with hundreds of different indicators
- Extensive charting features
- Options statistics and trading
- Economic news integration
- Company profiles and news
- Live streaming media
- Trading Simulators
And many, many more. It starts to look quite complex!
This stuff needs a lot of software development and maintenance, which is why it comes at a price that is reflected in the brokerage’s fee structure.
What the bells and whistles are good for
Think about what we used to build our trading system in this course:
1) simple, free daily chart data and
2) Two indicators (the simple moving averages). For the breakout buy signal you don’t even need those ones.
3) A bit of spreadsheet work
When I started with trading, I loved those fancy software features. I tried one indicator after another and spent a lot of time figuring things out. How much do you think it improved my trading performance?
If anything, it actually decreased it!
It’s absolutely OK to try new techniques, new buy signals etc. I learnt a lot about technical analysis and how to read charts, and some of the curves I learnt about I still use today… so it’s great to work through that kind of stuff, IF…
- You have a lot of time, and
- You understand that there is no silver bullet for finding the “best” way to choose stocks
In the end, what made my systems perform was disciplined risk management; not finding one or multiple new indicators to identify a better buying opportunity.
What I am using today
I was very addicted to these powerful software packages.
Then one day I received an e-mail from my online brokerage, telling me that they will no longer provide their services for my country of residency… oops.
I was very upset about that. What would be now my replacement software?
In hindsight though that was the best thing that happened to me.
My first solution was to look for a new brokerage with a software that has a similar selection of features (that’s many years back) – I did not care about pricing or trading fees. That did not work out because I could not find any.
My second solution was to search for a trading software that is not part of a brokerage firm – so if my brokerage should abandon me again, I would still have my trading software of choice.
Now my objectives changed – I wanted a brokerage just for facilitating my trades.
No bells and whistles anymore, only executing orders at the lowest possible price. I found one and signed up while continuing to search for a replacement software.
And something interesting happened. I realized that suddenly, my trading fees had plummeted… by a factor of 10! Previously, I had paid $25 per trade (a “special offer”). Now I pay on average $2.50.
You might think that’s not such a big deal…
How fees affect trading performance
With $100,000 in your portfolio and 100 trades per year, you would pay the first broker $2,500 in fees per year.
That’s 2.5% of portfolio value :(.
With my new broker, those fees went down to $250, or 0.25% per year. Way better!
Have a look how fees impact a $100,000 investment over 10 years, with an average yearly growth rate of 8%. The chart below shows the total gains (not including the initial 100k$).
That looks pretty bad.
With low fees of 0.25%, the performance is close to the No-Fees scenario. But the 2.5%-Fee case performs much worse.
Let’s look at the numbers to get a better idea:
That looks terrible!
If we would need to pay 2.5% fees per year from our $100,000 investment, then total fees would be $34,440 over 10 years.
But because the money that went into fees is not available anymore to reinvest, it creates an additional opportunity loss of $13,849.
That means that the investment performs lower by $48,289 compared to the non-fee scenario.
That’s a huge amount… nearly 50% of the initial capital invested. That’s why the total return is only 68% compared to 116%, or 111% for the 0.25%-fee case.
I think I made it clear by now:
Fees are a serious performance killer.
That’s why I was very happy that my trading fees were suddenly much lower than before.
But the story does not end here.
I still was looking for a fancy trading software. I finally found one… and I found I have to pay a $99 per month subscription fee (for the basic edition – up to $199 for the “professional” edition).
That’s close to $1,200 per year, or 1.2% in case of a $100,000 investment.
So, I asked myself:
Will I be able to increase trading performance consistently by 1.2% compared to using a spreadsheet-based trading system?
And after some thought I decided… nope.
There was absolutely no proof whatsoever based on my past experience that such software will improve my trading performance.
That’s how I decided to forget about using such software.
If something that costs money does not increase income… then it’s a hobby.
I switched to using spreadsheet software and web based charts and have not changed this setup since – because it works and improves performance.
It’s about your personal needs
In the end, it’s up to you.
You should try to find out by yourself which software you are comfortable with. I needed a nudge to change my approach, and I never looked back.
But maybe once you use such software you can proof that your trading performance is improving. If it’s enough to offset costs, by all means, go for it.
I suggest you start simple and practice the trading basics. Once you gained some experience, you can switch to a trading software and test if it works well for you.
One example of such software is eSignal. You can check them out at www.esignal.com. Their pricing has changed somewhat since I tested it (upwards, obviously). There are many others available, too.
Trading with apps
As I said earlier, most online brokerages also have a smartphone app available.
Some, like Robinhood, have only an app and nothing else. There is a trend for using more and more apps instead of classic desktop software.
I tried the smartphone apps of several online brokers, and most of them were doing a good job.
But I stopped using them altogether… why is that?
Again, it’s just personal preference:
Reason #1: Security
If I lose my phone, someone could access my online brokerage account.
Despite secure login and encryption, I do not see enough benefits to take such a risk. Every day you can read about some security breach in one or another company’s customer data or software… and I doubt that online brokerages are the exception.
Convenience: Yes, it’s usually convenient to use an app instead of walking over to your PC.
But with high security features enabled, it’s a pain just to login. I just feel it’s a waste of time to fiddle around with that. Plus, my spreadsheet is still on my PC, and I like to keep it ready for updating.
Stress: I do NOT want to check on my account every 5 minutes.
All I see is ups and downs that are simply noise, providing neither value nor insight. Instead, it’s psychologically stressful to see your portfolio go into the minus… even if you know that it’s just a short price dip.
Most online brokerage firms also offer a trading simulator.
A trading simulator usually looks like the real trading software of the brokerage firm, but you do not trade with real money. You can create orders, use the historic data, charts, indicators and all the other nice tools that are part of that software.
It’s like using a flight simulator instead flying a real airplane 🙂
There are 2 reasons to use a simulator:
1) To get used to their software, test features, know the interface, what buttons to push, etc.
2) To test your trading strategy without risking your money
I am fine with reason #1. These trading software packages are powerful and it takes time to get used to all the features that are included, even if you do not plan to use them all.
After playing around and making a couple of simulated trades, you will be confident about how to use the interface in a quick and efficient way.
But I am struggling with reason #2. It does sound compelling: test your ideas without being penalized financially in case you were wrong. And being wrong happens quite a lot in trading.
I used a trading simulator once, and I found it useless. Here’s why:
Wasting time and profits:
Testing a trading strategy needs enough data – at least 6-12 months of trades, or at least 100 trades.
Let’s assume the strategy works… then you left a year of profits on the table. And maybe it stops working afterwards… because the market behavior switched into a different phase.
Unrealistic psychological environment:
More importantly, simulation is NOT like the real thing.
Losing simulated money does not hurt. Selling at the set stop price is just a click of a button, not pondering over what would happen if you don’t sell and wait for a future price recovery.
Imagine you have a simulated cash of $100,000.
You trade with a high-risk setting and your portfolio takes a dive to $50,000, just to recover afterward. After 12 months of simulated trading, you are at $250,000.
That’s an amazing result!
Now imagine it’s real money.
You spent years (maybe decades) earning and saving it. Your mother-in-law chipped in some of her savings and your spouse asks you every day how your investment strategies are doing. You remember your simulated trading risk setting and you use the same now.
And every week your portfolio value goes down further… $95,000… $90,000… $85,000…
Can you withstand the ever-mounting pressure of losing money? The doubtful looks of your better half?
Can you hold on until you are down to 50% of your initial cash? Can you be sure that you will recover and make amazing returns until the end of the year?
Maybe you will feel more like this:
The truth is, most people cannot take such losses.
Drawdowns of 15% within one year are normal in the market (just look at the S&P-500 index over the last 10 years), but even that is tough. It makes you doubt yourself and your trading system.
So, in conclusion, I think using trading simulators is a waste of time and money. It’s not telling you anything about how you will do in real trading.
What’s the solution?
First, use a trading simulator only to get familiar with the software, if at all.
Second, start trading with real money, but with small amounts. Turn down your risk setting (for example to 0.1%) and keep 50% of your cash on the side.
Once you have practiced more and you gained some confidence in your trading system, change your risk setting to your planned setting and use most of your cash for trading.
Should I have more than one online brokerage account?
It’s not a bad idea, as long as you have enough money.
Many brokerages wave some fees if you put more cash into their account. The difference can be substantial.
I signed up for a brokerage firm once that had a $99 per month fee… that was just their default. I negotiated with them to wave the fee if I put more than $50,000 into their account.
That saved me nearly $1,200 per year or 2.4% of the account value. That’s a lot of money as we discussed earlier already – just check the “Impact of Fees” chart above.
However, there are good reasons to use more than one account:
- Diversification: in the, hopefully unlikely, event that a brokerage firm goes bankrupt, your money is split up between different firms, potentially minimizing your losses.
- Availability: if you want to place a trade and one site is offline, you can do the trade with the other brokerage firm.
- Different Trading Strategies: if you implement different trading strategies, it’s easier to use one account for one strategy, and the other for the other strategy. E.g. one account could be a buy & hold strategy, and the other one could be a trend following one.
I do not think that additional fees justify any of the above reasons.
It’s also more paperwork for you. At the beginning, I would not bother having two accounts, but the choice is yours.
Established online brokerages
As I said earlier, I would always choose a brokerage firm that has been around for at least a couple of years.
Here are the items that I look out for when choosing a brokerage:
- In business for at least 5 years?
- Can I trade the markets I am interested in through them?
- Can Non-U.S. Residents sign up? (if applicable to you)
- Can I trade from my current country of residence?
- Can I deposit and withdraw funds easily?
If any of the above points do not work out then… fail.
This concerns primarily American brokerage firms, if you are looking for others then there might be different things to watch out for.
The next thing I do is looking at their fee structure.
Over the last few years, trading fees have been decreasing due to a price war between brokerage firms. There were also many consolidations, i.e. the number of firms is decreasing, as competitors continue to merge or buy each other.
Here is my list of brokers that have been around for at least 5 years:
Where to find good reviews
My number 1 place to check on brokerage firm reviews is Barron’s: www.barrons.com.
Every year they make a review of online brokers that goes into a lot of details. You can find one for 2017 here: http://www.barrons.com/articles/barrons-2017-best-online-broker-ranking-1489811850.
Here is an example of the ratings:
Other places for comprehensive reviews can be found here:
One thing I like about these online brokerage firms is that they are transparent about their pricing.
All of them have a pricing page that lists all fees that might apply. But because there are so many fees, it’s difficult to make a decision.
I based my choice on costs per trade.
Some brokerages offer a flat fee per trade – that is good if you make few trades but with many stocks in each.
Others offer a fee per share (and often with a minimum fee attached), which might be better if you trade more often, but a smaller number of stocks.
There are many other fees, for example:
- Wire fees for deposits and withdrawals
- Inactivity fee – if you do not make any trades over a period of time
- Fees for paper statements
- Broker assisted trades
- Margin interest (if you borrow money from them to leverage)
- Option exercise
- Commission fees for buying mutual funds, ETFs etc.
- IRA fees (if applicable)
Make your choice based on your situation.
If you make frequent transfers, in or out, then you might need to look for a brokerage firm that has low transfer fees.
Other issues to look out for
There are also other things you should be aware of.
For example, for security reasons, brokerage firms might not let you transfer funds to or from a bank account that has a different name than your brokerage account.
So, if you have a joint account with your spouse, you might not be able to transfer funds between this account and your brokerage account.
Get a written confirmation from your brokerage firm about that transfers are possible before signing up.
Another thing is their sign-up process. Check out how it works, because with some it’s easier than with others.
Some brokerage firms offer a 100% electronic (i.e. online) process – which is great if you are busy and you do not want to print and send documents across the world.
Others are more traditional and you will need to download and print forms, fill them, attached related documents and send them to their office.
It’s a pain, but you do not need to do it that often.
To sum things up…
Do your research before signing up with a brokerage firm.
The sign-up process takes some time and effort, and changing later to a different one can be a real pain. Make sure your candidate firms tick all the boxes for what you require.
Then, check out their fee structure. Fees can make the difference between long-term good performance and no performance at all.
In the worksheet for this lesson, I will explain how to create a fee simulator. Once you have an idea about the fees you might need to pay, plug them into the simulation to see how they affect long-term trading performance.
Now go and look for a brokerage firm!
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Get the Lesson 7 download:
Click on the image or button below to get the 22-pages PDF file.
In the lesson worksheet I will show you how to create your own fee simulator, using spreadsheet software:
- Build and compare fee scenarios
- Create your fee simulation
- Collect brokerage fees
- Simulate fee impacts
- Fee impact chart for long term investments
- Comparison table