Online brokerages like Etrade or TDAmeritrade allow an investor to make immediate decisions on investing in stocks. There is no broker to review the trades, and traders can run up large commissions quickly by trading too frequently.
Commissions on Internet Stock Trades
Online brokerages charge commissions range from as low as $4. Some brokerages charge more, and full service brokers have higher commissions to offset additional services. If the primary goal of an investor is only to buy and sell stocks, the lowest commission rate may be the best one.
Brokerages generally give their lowest rates to those that buy stocks over the internet. Higher commissions are charged for the same trade if made by automated telephone systems, with the highest rates for broker assisted transactions.
Bid and Ask Price, Spreads and Market Makers
Once an account has been set up for internet trading, the investor selects a stock and quantity to buy. In a cash account, the investor is limited to the amount of money he has in the account. It is therefore important to know the price that he will have to pay for the transaction, including commissions.
Two prices are provided for each stock. The higher of the prices is the ask price, which is the price that the investor will have to pay to buy the stock. The lower of the prices is the bid price, or the price that the investor would be able to sell shares.
The difference is known as the spread. The spread results in additional fees that are in addition to any commissions charged by the broker.
Example of an Internet Stock Trade
An investor wishes to buy 100 shares of XYZ Company. The ticker symbol for XYZ shows that the bid price is $9.95 and the ask price is $10.00 with a commission of $7.00. The person making the trade will pay $1,007 ($10 * 100 + 7).
If the stock does not change at all (which is unlikely) and the trader decides to sell the stock, he receives the bid price of $9.95, not the ask price of $10, less another commission, leaving him only $9,943, ($9.95 * 100 -7.) Even though the price is unchanged, the investor has lost $64 dollars.
How to Make Better Stock Trades
From the example above, it is clear that investors need be careful when trading:
- Investors should minimize the difference between the bid and ask has much as possible. Thinly traded stocks (that is, ones that have less daily volume) are likely to have wider spreads. Also, spreads often decline during the day, highest spreads occur when the market first opens.
- Trading often will lead to more money spent on the spreads, and on commissions. Often, holding a stock through market volatility will improve investor performance.
Investors have different time frames and risk tolerances. Making sample trades will help investors learn the best methods that work for them personally.