The investor needs to decide on which type of broker to use
The Role of the Stock Broker
A stock broker is required to buy or sell stocks on the stock market, and they are commonly referred to as a Broker.
The stock broker’s first role is to forward your trade order on to a stock exchange or to an ECN (Electronic Communication Network) so that your order can be filled:
Stock Brokers first role:
- When stocks are purchased – they are bought from someone who is selling them (which can be an investor, a trader or a market maker).
- When stocks are sold – they are sold to someone who wants to buy the stock (which can be an investor, a trader or a market maker).
The stock broker’s second role is to settle your stock:
Stock Brokers second role:
- For a stock purchase – the stock broker will arrange for the stock ownership to be transferred into your name and will forward the payment to the stock seller’s account.
- For a stock sale – the stock broker will arrange for your stock to be transferred across to the stock buyer’s account and will deposit the payment received into your stock trading account.
Types of Stock Brokers
Stock brokers charge a commission for these two services and the fees vary depending on which of the three main types of stock brokers is used.
- Full Service Brokers: they are the oldest stock broker type. They provide an additional service of monitoring their client’s stock portfolios, however this comes at a significant premium in the commissions charged. They are often criticized for influencing their client’s to trade unnecessarily in order to generate additional commissions, but they are still used nowadays primarily by stock investors who do not have the time or desire to conduct their own research.
- Online Brokers: these are stock brokers that are accessed via the internet and they are relatively cheap to use. Their popularity has increased dramatically over the years. They do not provide a portfolio monitoring service, but they generally provide access to company research reports, financial news and fundamental data via their websites. This allows the stock investor to make their own informed decision on any proposed stock purchases or sales.
- Direct Access Brokers: they are also stock brokers that are accessed via the internet, but with this type of stock broker, trade orders are always placed directly onto the order book and the client can decide which exchange or ECN their order is directed too. They are generally the cheapest stock brokers to use, but are intended for the more experienced and active stock investor. Their research information is generally the same as the online stock brokers.
Selecting a Stock Broker
The decision as too which type of stock broker to use largely depends on the following factors;
- Whether the stock investor is comfortable with the process of selecting which stocks to buy or sell? Stock Investors who are educated in the basics of the stock market tend to prefer to make their own decisions.
- How frequently the stock investor or trader buys or sells stocks. Once the trading frequency increases, commission charges start to become quite significant.
- The typical position size per order placed. Generally all stock brokers have a minimum brokerage charge. For very small orders the minimum commission can be a large percentage of the trade order. For example, a $10 minimum brokerage to buy $100 worth of stock represents an effective commission of 10%.
- How long the stock investor holds their stocks before selling, if sold at all? With long-term stock holdings, the gains are significant and therefore the commission charge becomes less of an issue. With the more active short-term stock investors and especially stock traders, the gains are quite small and as such the commission charges need to be carefully considered.
The decision as to which type of stock broker to use is one that needs to be made by the individual stock investor.
Also, a stock investor can use more than one type stock broker and they can change the type of stock broker used at any time.
The more experienced active stock investors and especially stock traders tend to prefer direct access to the order books and hence will use a direct access broker.
Stock investors and traders starting out tend to prefer online brokers as they tend to be more user friendly.
Full service brokers tend to be more popular with those stock investors who prefer not to have any direct involvement with the stock market.