Providing investor education, product enhancements and software solutions on how to become a more successful online trader with The Investrio Mentor Center. Understanding the Stock Market The purpose of today's column is to provide you with invaluable insights into the Stock Market. Today’s Topic: Brokerages The most common way for you to purchase a stock is through a broker. Actually, the “broker” that you deal with is technically called a “registered representative” or an “account executive” and the company that your account executive works for is called a broker-dealer. For simplicity’s sake, in this section we will just use the word “broker” in the popular sense, to refer to the person that you tell to purchase or sell your securities. Commissions and Fees Brokers and brokerages (the companies that employ brokers) make money primarily by charging commissions. A commission is a fee that you, the customer, pay a broker in order to execute a transaction for you. The reason why you must go through a broker and pay this fee in order to trade a stock is because you yourself do not have access to the stock exchanges. Brokerages, however, have seats on the various exchanges and so they will trade your stock for you in exchange for a small (or sometimes large, as the case may be) commission. Brokerages also charge a number of other fees, such as for transferring funds into and out of an account. Since fees and commission vary from broker to broker, the best idea is for you to shop to around to see for what each brokerage charges. Cash Accounts The cash account is the most common type of account used at brokerages. As the name suggests, cash accounts are accounts into which you place your money in order to make a trade. You either must have enough money in your account to cover the trade at the time of its execution (including both the price of the security and the commission), or you must be able to pay for the trade within three days (this is called the settlement date). Some brokerage firms are now beginning to accept credit cards to fund cash accounts, but the overwhelming majority still require cash or a personal check. Margin Accounts Unlike a cash account, a margin account allows you to buy securities with money that you don’t have. How is that possible? You simply borrow the money from your broker. The Federal Reserve limits margin borrowing to at most 50% of the amount invested (so, for example, if you want to buy a share of stock for $100 you can borrow $50 at most on margin and you must pay the other $50 yourself). Some brokerages have even stricter requirements, especially for volatile stocks. People open margin accounts mostly to take advantage of an opportunity to leverage their investment, not because they don’t have the money to make the full purchase. By only putting up half the money for the purchase, investors realize a higher return if the stock rises (for example, using the preceding example, if the stock price doubles to $200 then the investor has actually quadrupled his or her original $50 investment; if s/he had put up the full $100 the investment would only have doubled in value). Brokerages charge a relatively low interest rate on margin loans in order to entice investors into buying on margin. As with any investment technique, there are downsides to buying securities on margin. Although buying on margin can give you the opportunity to make more money than normal, it can also lead to larger than normal losses, especially if the broker issues what is known as a margin call. A margin call is basically a call for the investor to repay the loan right away, within 24 hours. They are usually issued when the value of the investment drops below the amount that has been borrowed. In this case, the broker will want you to sell the security immediately in order to pay off your margin loan, which of course would leave you with nothing from your original investment. Discretionary Accounts Discretionary accounts are a special type of brokerage account that permit the broker to buy and sell shares for you without first contacting you for approval. You can also set up a discretionary account with an investment advisor who can make the same unauthorized transactions. If you’re going to set up a discretionary account, it’s probably a better idea to do so after going through our training, education & paper trading for at least a month. You can also do it through your financial advisor as the authorized party since they are supposed to be trying to maximize your financial well-being. Brokers, on the other hand, are not responsible for making you money; they are responsible for making themselves money and so they might make frequent unnecessary transactions in order to boost their commission. Broker Research Before sitting down to decide which broker you want to open an account with, you should probably do a little bit of research about the person who will be handling your transactions. One way to find out about a broker’s background is to call the National Association of Securities Dealers (NASD) , a self-regulatory agency of brokers. The NASD can tell you, for free, whether your broker has ever been convicted of a securities-related crime or whether disciplinary action has been taken against him or her. The other major resource that you can use to find out about your broker is the Central Registration Depository (CRD) system, a computerized database that has information on over 600,000 registered stockbrokers. The CRD can tell you about the broker’s employment history, his or her securities examination scores, licensing information, and any record of disciplinary action. In order to access the CRD, simply ask your prospective broker for his or her CRD number and then contact your state securities commission or the NASD. Choosing a Broker When choosing a brokerage, be cautious of advertising, especially the advertisements with comparisons of commission schedules. Instead, focus on objective ratings and use the list of considerations below to help you make your decision: Commission rates: especially for the types of trades you typically make. Range of services: make sure they offer everything you need (for example, if you will be trading foreign stocks, confirm that they are equipped for this). Quality of service: check the Better Business Bureau, NASD Regulation or your state attorney general's office for complaints. Minimum to open an account Account protection: confirm that they are SIPC insured. This will cover you for up to $100,000 in cash and $400,000 in securities. If you need more, discuss it with the broker. Fees and investment options for IRAs Margin rate (if you plan to buy on margin) Money market account yield Commissions on no-load mutual funds Inactivity fees How long you have to wait on hold when calling Local offices Other services (check writing privileges, credit cards, etc.) Click Here for a free 10 day trail of our Software, Education & Trading System. When choosing an online broker, the following extra considerations are important: Use of a secure server to handle all transactions. Types of investment vehicles: stocks, options, bonds, futures, mutual funds, foreign securities. Types of orders that can be placed. Most allow market orders, stop orders, and limit orders. Order execution speed. Some brokers use "drop copy" trading, in which a live broker reviews orders before they're executed, which can delay the trade by up to ten minutes. Order confirmation speed. Support, preferably by both phone and email, and preferably 24-hour. Amount of account information (and speed with which it's updated). Free or cheap real time quotes. Free or cheap research, market data and news, portfolio tracking, alerts, and planning tools. It’s a good idea to narrow down your list of potential brokers to a few that seem to meet your needs, and then to open demo accounts with each to see which you like best. Discount versus Full Service There are a few differences between full service brokerages and discount brokerages. The major tradeoff is cost versus services. Full service brokers will help you make decisions, whereas discount brokers won't. But the full service broker may not have your best interests at heart when making these recommendations (since he or she works on commission, there is always going to be a conflict of interest). Also, the full service assistance does not come cheaply: commissions are significantly more expensive at the full-service brokerages than at discounters. If you feel confident enough to select your own stocks (Using The Mentor Center) , it probably makes sense to go with a discount brokerage. Also, nearly all discount brokers offer online trading. Opening an Account Opening a cash account is perhaps the simplest step involved in dealing with a broker. You simply fill out an application form, sign it, and send in your initial deposit (minimum deposit accounts vary from broker to broker but usually fall within the $500 to $2500 range, so make sure you have enough money first). Opening a margin account, however, may be a bit more difficult if you have a poor credit history. You can also transfer an old brokerage account to a new one. The key here is to open the new account first and then ask your broker for the appropriate forms necessary to transfer the securities (if you’re transferring cash, then you can just ask your old broker to send you a check for your balance and then use the money for your new account). Stock Certificates When you purchase a security through a brokerage, you have a couple of options as to how you want to hold the actual security. You always have the option to request that the actual stock certificate be mailed to you and that the issuer place your name upon its registration list. Most often, however, people choose to hold stock in their brokerage's street name. When you hold a stock "in street name", your ownership of the stock is recorded at your brokerage but not by the issuer (they record your broker's name). You also will not receive an actual stock certificate, although your broker will forward you all relevant company correspondence, such as annual reports and proxies. Most people choose to hold their stock in street name because it makes it easier for them to sell later (since they don't have to mail in the certificate) and they don't have to keep track of the certificates themselves (there are replacement fees if they are lost). Recently, some companies have been allowing "direct registration" of stock that allows you to have the security registered in your name without holding the actual certificate. You can check with your broker or the company issuing the stock to see if this alternative is available. Regulations and Fraud In order to buy and sell securities for you, your stock broker must have passed two examinations (called the Series 7 and the Series 63) and he or she must have a valid broker's license issued by the National Association of Securities Dealers, a regulatory agency for brokerages. Unfortunately, these regulations do not completely prevent ethical violations from occurring in the brokerage industry. You can, however, take action against your broker by contacting the NASD or the SEC for possible code violations if he or she has done one of the following activities: Churning: Your broker cannot trade excessively on your account in order to boost his or her commissions. Deception or manipulation when talking to you about your securities. Unauthorized trading on your account. Guaranteed that loss of investment will not occur. SIPC The Securities Investor Protection Corporation (SIPC) is a non-profit, non-government corporation that insures brokerages in the case of a firm failure. The SIPC is funded by all of its member securities broker-dealers, and it will replace up to $500,000 per customer in the event that a brokerage runs out of funds to cover its claims. The SIPC does not, however, insure you against losses to your investment. Broker Recommendations While stock picks from brokers can be useful information, they should not be relied on too heavily. Brokers usually have significant conflicts of interest that affect their recommendations, and so all information coming from them should be taken with a grain of salt. After all, brokers are paid based upon how many times you trade, so some are tempted to recommend that you trade more often than necessary. They may also have other motives for getting you to buy a particular stock or to trade at a particular time. The best idea is to usually use a broker for simply buying and selling securities and not for advice. Doing so will also save you on commissions if you choose to use a discount broker as opposed to a full service broker. Remember our words of wisdom. No one cares about your money as much as you do. Use our software, training & education to take back control of your finances. Don't leave your family's future in someone else's hands. Thank you again, for the opportunity to share our knowledge and experience with you. For all the latest information, news & updates please visit us again online. “More Millionaires have been created from the stock market than any other source” --Bloomberg Magazine Copyright © 2000-2003 Wall Street Mentors Inc. All Rights Reserved. Member Access |
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