|Full Service or Online?|
Hopefully this article will open your eyes to the realities of transaction costs. While experienced traders should look for low rates with quality service, novice traders will benefit greatly from the hand-holding of a good broker making commission paid an investment rather than an expense.
If a broker guarantees that you will make money trading with him I suggest you hang up the phone. There are no guarantees in options in futures trading; however, an ethical broker will provide exceptional service at a reasonable price in order to ensure that you are provided the best odds of success. Additionally, it is important to realize that in many circumstances the amount of commission paid, or not paid, doesn’t normally have an impact on whether you are profitable or not in the long run.
Sometimes Less actually is More
If you are an experienced trader, there is no reason for you to pay hefty commissions for a service that you don’t necessarily need. Placing self directed trades online is economical and efficient and if ready, you should take advantage of every opportunity to do so. With that said, when it comes to open outcry option trading your best bet is to work with a broker that has direct access to the trading floor. Placing such trades online is arguably much more expensive in terms of fill quality than paying a broker could ever be.
Clearly there will be times in which you are away from your computer or are experiencing technical difficulties and will need assistance in placing your trade. A quality brokerage firm will allow you to place your trade through a broker or trade desk during such times with little or no financial consequences. Nonetheless, if so, your firm is relying on good faith by their clients. If you are a habitual offender you have just increased your service level, reduced your risk and aren’t compensating your broker for their efforts.
Full Service doesn’t have to be Expensive
People tend to assume that full service is synonymous with expensive. While this is sometimes true, it doesn’t have to be. There are brokerage firms out there that charge excessive commissions and fees; however, a good brokerage firm understands that higher transaction costs deter from the client’s ability to profit and in turn become a long term customer.
You should be weary of firm that offers set commission rates to all clients regardless of size, experience, volume and account size. Doing so results in a scenario in which certain types of clients are indirectly subsiding the trading practices of others. This logic can be compared to an insurance company that collects the same life insurance premium for a sixty year old smoker as a twenty one year old athlete. Just as insurance firms realize that this type of practice isn’t equitable to its policy holders, I believe that brokerage firms should adopt a similar policy. A quality brokerage firm understands that the needs of each client differ and their cost of trading should reflect these discrepancies. Additionally, those that are offering blanket commission schedules are likely cutting corners in other places too.
Only you can decide how much commission is too much to pay. However, you can’t argue with the bottom line. If you are racking up a large commission bill and your account isn’t making progress you may question whether or not it is worth it. However, you must also be aware of how much of your account drawdown is due to commission and how much can be attributed to trading losses sustained by your hand. Be honest with yourself as to whether the trading may have been better or worse without the help of your broker. This is difficult to do. By nature we are always looking for someone or something to blame for poor trading results and your broker is an easy target.
Is your broker working for you or for your commission?
There is a big difference between a broker that works for you and on that is simply looking to collect a transaction cost. If you feel as though your broker is putting his best interests ahead of yours, don’t be afraid to confront him. It is your money and you should be completely comfortable in how you and your account are being handled.
Unfortunately, because the brokerage industry thrives on commission it can be easy for account executives to succumb to the pressures of generating income “now”. After all, they have bills to pay too. However, your broker’s financial stability shouldn’t have an effect on the trading in your account. I would like to think that brokers with this type of mentality are the exception rather than the rule, but it is important that you fully understand the potential motivations behind the industry in order to avoid a compromising situation.
Why using a broker may be a good idea
Avoid Over-Trading and Panic Liquidation
Working with a broker may mean having someone to “bounce” ideas off of and hold your hand through good times and bad. Under most conditions, the trading decisions made in your account should be yours but you can’t deny that your broker will have an influence. If you are with the right account executive, it should be a positive influence.
A second opinion from a seasoned professional can be “priceless”. They have the luxury of keeping fear and greed out of the decision making process and hopefully have the market experience that you are paying for through commissions to aid in their advice.
Shifting Risk of Order Placement
You have likely heard the old adage, “Don’t chase over dollars chasing pennies”. This is the best way that I can explain the idea of a trader pushing himself to trade without the help of a broker before being truly ready. One of the biggest benefits of using a broker is to shift the risk of error in trade placement from yourself to your brokerage firm, or more specifically your broker.
If you call your broker and ask her to buy a July corn at the market and she inadvertently sells a contract she is responsible for making your account “whole” again. In other words, your broker must liquidate the accidental position and execute your order properly as well as compensate you for any additional damages including the commission charged on the mistaken trade. Naturally, if you tell your broker to buy July corn at the market and she does, the rest is left to your ability to speculate, the timing of your exit and fate.
If you aren’t completely comfortable in your knowledge of the markets and placing trades, it isn’t wise to do so. Mistakes can be costly. I have seen online traders loses hundreds or thousands of dollars simply because they were unprepared for online trading but insisted on saving $5 in commission. Examples of common mistakes are unknowingly executing trades in extremely thinly traded markets, buying or selling the incorrect number of contracts, selling instead of buying or vice versa, placing a stop order when it should have been a limit and vice versa.
Many of the mistakes made by inexperienced online traders stem from a lack of emotional stability. Whether looking to get out of a trade gone bad or to take a profit on well speculated position, exiting a market can be psychologically challenging. A good broker can’t save you from yourself, but he may be able to eliminate some of the risk by being aware of your positions.
While most retail traders don't fully understand SPAN, or Standard Portfolio Analysis of Risk, a seasoned broker should. It is difficult to put a monetary value on the ability of relieving a margin call without wiring money or completely liquidating positions. Possible margin adjustments may include buying or selling options as a hedge against current positions or it may involve the purchase or sale of futures to do the same. If you are unaware of the mechanics of SPAN working with a broker will be well worth the commission paid should you ever get into a tight margin situation.
This may sound corny but many traders find that the people that they are closest to either have no interest or have no knowledge of the trading world. Thus it can be hard to have a full blown conversation with friends and family but your full service broker will always be there for you.
Ensure Limited Slippage
A full service broker will work hard to make sure that you are getting fair fills. While slippage is inevitable, questionable fills can be contested and are often a simple error on the part of a floor clerk or broker. An online trader must be much more proactive in getting time and sales data to confirm fill prices and getting an adjustment on a previously reported fill.
Saving money in commission may actually be more expensive in the long run than paying a full service broker. This is because there is a substantial amount of risk involved in trade execution and if you aren't comfortable with your knowledge of the markets, trading platform and psychological stability when it comes to trading you and your account may be an accident waiting to happen. However, if you are an experienced and well informed trader you should be looking to trade online at a reasonable rate as there is no reason to pay for service that won't help you reach your goals.
**There is substantial risk in trading options and futures.
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Carley Garner, senior analyst at DeCarley Trading, is the author of "A Trader's First Book on Commodities" and “Commodity Options” published by FT Press, a division of Prentice Hall. Her trading e-newsletters, The Stock Index Report and the Bond Bulletin, are widely distributed and have garnered a loyal following; DeCarley Trading is proactive in providing free trading education.
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