Category: Online Investment
Investing online through a
Market maker or an ECN
Online investment can be made through two different types of brokers: market makers and ECNs (Electronic Communicating Network). Before starting to trade, the investor must determine which type of broker is the best for him. Both of these type of brokers have several advantages and disadvantages.
Trading through an ECN
First of all, the beginner investor must understand what is an Electronic Communicating Network. ECNs are the connection between market participants (for example: individual investors, banks or other market makers). The ECN displays the incoming offers and bids of the market participants for other market participants. Because of this the market is determined by them, so there is no fixed spread (spread is the difference between bid and ask price).
ECNs charge commission for each trade made through their trading platform. The commissions depend on the ECN. Mostly the charges are dipping when the traded amount is more at a fixed time period.
ECNs usually have better bid/ask prices, because the incoming offers come from more market participants. The prices are more volatile, because they are influenced by more trader. This can be an advantage for scalpers. ECNs pass all of the orders for someone else, so they are not motivated to trade against the market participant.
On the other hand, electronic communicating networks usually do not have a user-friendly trading platform (developing a user friendly trading platform has got huge costs). The price of the instruments are more volatile, so to determine a stop-loss is more difficult. The ECN charges for all of the exercised transaction.
Trading through a market maker
Market makers have got own trading platforms, too. But they set their instruments prices, which are mostly following the prices of the instrument. The market maker company must make a deal with the market participant on his quoted price. These companies stay on both side of the market, so when the investor is buying an instrument, the market maker must sell it and when the investor is selling an instrument, the market maker must buy it. These companies offer a larger spread for the investors and they benefit from the spread.
Market makers have usually a very user-friendly tradnig platform. The quoted prices of the instruments are less volatile, which is more confident for beginner investors. A market maker company is more often used for long time investments, not for active day trading.
| Market makers must exercise a trade on their quoted price of an instrument, so there is a clear conflict of interest in order execution between the trader and the market maker company. So they may trade against the market participant. Their quoted price can be different from other market makers or ECNs. When the investor is using stop-loss, the market maker company can move the price of the instrument to run out the investors position. So the market participants trade generates loss for himself and the market maker generates profit for himself. An other typical feature of a market maker company is the so called “freezing”. When news are released, the prices of the instruments are going to be extremly volatile. During this time the investor can not trade. |
Investing through a full-service brokerage
| Full-service brokerages offer a wide range of financial services, including instrument research, tax tips, retirement planning and much more. These services cost a lot of money for the company. So these brokerages charge more commissions at each trade to cover they costs. Trading with a full-service brokerage is more useful for that investor, who has got capital and work a lot, so they do not have time to research for information. The cost of a trade at a full-service brokerage can be 20 times more than at a discount brokerage, so the investor must think about the usefulness of the provided information. Is it so much worth? |
Minimum capital
The required capital to use a full-service brokerage is not determinated, but usually it is more effective to use a full-service brokerage when the investor has got more than US$200.000 to invest. The costs of these brokerages are really high, so the invested capital should be a lot more than for example at a discount brokerage. Moreover, the time cost of the investor must be high, too. It should be more worth for the investor to pay for the extra services of the company than to do it by yourself.
Commissions and fees
Full-service brokerages usually do not charge for the extra services directly. The extra services are paid through the trading commission, so when for example a discount brokerage charges maximum US$20 for a trade, a full-service brokerage charges 150$ or more for a trade. The investor must know his type of person. He must decide whether to trade as an active trader or to be a buy and hold investor. If he is a buy and hold investor, who does not have time to do research and analysis, a full-service brokerage is the right brokerage firm for him.
Personal financial management
Full-service brokerages offer a personal financial management, which include retirement planning, taxation analyses, financial analyses, life insurance needs analyses and much more. But these services are available only for those investors, who have a minimum account balance of a few million dollars. For example, the investor has got US$1 million and buys an investing fund. The entry fee they receive is 1% (not too much regarding to several investing funds), the full-service brokerage earns US$10.000. From this amount of money the company can lightly pay the fees of the workers, who do the extra services.
Investing through a discount brokerage
| Discount brokerage is a better decision for a beginner investor, because full-service brokerages charge more commission for every trade. Moreover, when a beginner investor starts to do the research and the actual work, he learns what to do. There are several important factors to consider when choosing a discount brokerage. |
Minimum account balance
When a beginner investor does not have a lot of money to invest, he must do some research about the discount brokerage companies, because the minimum account balances can be different. Moreover, for example margin accounts can have different minimum balances, too. So there can be a situation, when an investor does not have enough money to open an account at a chosen discount brokerage, but he can open an account at another discount brokerage.
Commissions and fees
The trading commissions can be very different. The investor must decide, what is the most important for him. When a beginner investor does not trade daily, there is no importance for him that his trade is going to be exercised in a few seconds or in several minutes. Moreover it is not a difference when a trade commission is 9$ or 15$. Usually the service level depends on the charged commission. So the investor must decide what is more important for him, the service what the brokerage offers and gives or the charged commission. The other fees can be different, too. Some discount brokerage companies charge fees for special services, some do not.
Withdrawal
The money on the account is the investor’s money, but sometimes it is hard to get it. Several brokerage companies charge fees for withdrawal. Moreover, they do not let the investor to drop the account balance below a minimum. Before opening an account, the investor must ask about the withdrawal fees, the minimum balance and the cost of the closing an account.
Research
Several brokerages make research, but most of the investors do not want to pay for that. There are a lot of researches on the web. There are sites, where researches are permanently refreshed. For example, some of them include prediction of the instrument in the future, analyst report and useful information.
Tradable instruments
It is important to determine what kind of instruments want the investor to purchase before opening an account at a brokerage. Most of the stocks can be traded at all of the discount brokerages. There can be instruments, which the investor can not trade at a brokerage, but he can trade with that instrument at another brokerage.