The stock market is one anyone can recognize because it is the most talked about financial market in the world. Every financial news channel will always have a segment where they talk about the best and worst performing stocks of the day. Stocks are so popular because they have been around for decades and became common since the late 18th century after the Buttonwood Agreement.
Anyone looking to make an investment must have considered buying stocks, and that’s because it provides a sense of ownership in the company. This preference for investing in stocks is even higher nowadays because you don’t even have to physically meet a broker buy and sell stocks, everything can be done online. Many stock brokers have made their services available online, such that they can reach out to even more clients around the world without the limitation of geographical location.
This has made the stock market even easier to access for the average individual, but there’s also a downside – the rise of unscrupulous brokers. This seems to be the major downside to most online business transactions, because it is far easier for the brokers to avoid detection. This should not discourage anyone from trading stocks online, but should only be a word of caution. Before we go any further into how one can avoid these unscrupulous brokers, it’s best we first looked at how the online stock brokers operate.
Behind the scenes of an online stock broker
Every stock brokerage begins in the same way, whether it be physical or online – a connection to the exchange. As you may know, a company first lists its shares through an IPO at an exchange. Afterwards, that company’s shares can be traded at will by those who own the shares.
As an example, let’s think of company EFG which is listed on the New York Stock Exchange (NYSE). The first layer would be the floor brokers who are located at the exchange and they receive orders to buy and sell EFG stocks. These floor brokers deal directly with investment banks and hedge funds, basically, companies with high-value orders. The second layer is made up of the supplemental liquidity providers (SLPs) whose role is to provide liquidity. Just like in the Forex market, the SLPs are market makers and they have to accept the orders they receive.
Finally, and here’s where we come in, are the designated market makers (DMMs) who are just brokers linked directly into the exchange. Therefore, they get live market price quotes from the exchange, but they are not required to create a market like the SLPs. The top stock broker are usually DMMs, because they will have the required capital, but more often they are just connected to another DMM or SLP.
Regardless of their connection to the exchange, the broker is going to receive actual market prices for company EFG. Nowadays, exchanges have advanced computer systems that are updated every few seconds so that the quotes always reflect the volume of traded shares. The stock broker will receive the market price of each share, but you will get bid and ask prices. The bid price is the price at which a sell order is filled and the ask price that of a buy order. The difference between the bid and ask prices is the spread, and it is up to the broker’s discretion to set the spread. Factors that influence the spread include:
- Demand for the stock – if a stock is not in high demand, such as small-cap stocks, the spread is usually higher because the broker will have a harder time finding someone willing to take the opposite side of the trade
- Volatility – when the markets are volatile, spreads will be higher because of increased demand. The broker knows that more people want the stock and they will widen the spread to make more money off of the trade
- Mass selling/buying – there are times when you find most traders taking one side of the trade, for example, after news about the company is released. In such situations, the broker will find it harder identifying a trader who will take the opposite trade, and they will tax the traders through wider spreads
It may seem like the brokers are being cruel and self-serving, but it is important to remember that they, too, are taking a risk by filling orders when the client demands even before they have found someone to trade against you.
Once the broker has analysed the markets and arrived at the bid and ask prices for a stock, they will then relay this information to their clients. In the past, this would usually be through a phone call or a physical visit to the broker’s office, but now these quoted can be delivered online through a trading platform.
When you place an order, that order is transferred by your broker to the exchange either directly or through a DMM or SLP and you will own a stake in the company – if you have bought shares.
Even though the structure above is about the NYSE, other exchanges around the world have a similar structure, even though the players may have different names.
How to stock brokers differ?
You might now be wondering why you even have to care about your choice if all stock brokers operate in the same system, but there will still be certain differences.
The primary form of charge imposed by the best stock brokers is through spreads, which we have discussed above. However, since these are set by the broker, they will differ from one broker to the other. Top stocks brokers will try to keep their spreads reasonable such that they do not take away from the clients’ profits.
For example, if the bid and ask prices were $8 and $10 and difference between them $2, then the spread would be 20%. To break even, the trade would have to make a 20% return, and the client would only start making a profit after a 25% change. As you can see, the spread is a very important factor to consider. When looking at the top stock brokers list, make sure you know how much of a spread you can expect.
Beside the spread, most of the best stocks brokers will impose a commission on the trades. Fortunately, this doesn’t change with the markets, and you can easily determine how much of a commission to expect. Another advantage to stock trading is that it doesn’t incur holding charges since you literally have a stake in the company.
Number of stocks available
Brokers are not limited to any single exchange, and they can be linked to several exchanges simultaneously. Top stocks brokers will be connected to several major stock exchanges so that they can deliver many stocks to their clients. NASDAQ, for example, has over 3,000 stocks listed while the London Stock Exchange has over 2,500 listed companies. Of course, you can’t expect to have all these stocks available to you, but the more exchanges a stock broker is linked to, the more top stocks you will have access to.
Minimum capital requirements
Stock trading will often require a higher amount of capital than, say, Forex trading. The stakes are much higher because they involve actual ownership of company shares unlike CFDs which just track the underlying asset. As such, there will be a minimum capital requirement and you will need to put down at least 50% worth of the trade before your order is filled.
Fortunately, top stock brokers will offer leverage that will allow you to trade even with only a small initial deposit. When looking for a stock broker, find out how much leverage they offer and the minimum deposit they can accept. After that, it’s just a matter of deciding whether you can match their requirements.
When trading stocks online, you want a reliable trading platform that you can easily access and use. A top rated stock broker should have a downloadable trading platform that you can use on your computer or smartphone. Through the platform, you will be able to monitor the performance of your trades as well as analyse the stock markets thus making you more profitable.
How do you identify the best broker?
When you know how they differ, picking one from the best stock brokers list becomes a lot easier. You just need to find out if they can offer you the best services compared to their competitors. Still, there is no substitute for direct input from other traders, and you can always find information about a broker on stock brokers reviews. On such sites, you get input from other traders who have dealt with the brokers and learn more about their services.
Also, remember that cheap is not always best. Some stock brokers will lure in traders by offering the lowest charges and the tightest spreads. At face value, this would seem like a real bargain, enough to get you to sign up and make a deposit. Offering stock trading services is not cheap or easy, and you should always be suspicious of any broker that offers unbelievably low charges. Always check that the broker is regulated by the CFTC before signing up because otherwise they would just be running a scam.