The definition of an online broker is an intermediary between a buyer and seller of a financial instrument. They facilitate the purchase/sale for a fee or commission. With the advancement of technology, traders and investors alike can transact online, courtesy of online brokers. Read on to learn more about online brokers, including which one is right for you.
Overview of an Online Broker
By definition, an online broker is one which facilitates buying and selling of a security over an electronic network. The transaction is usually effected through the broker’s proprietary trading platforms. This is opposed to the traditional method of placing orders via phone call.
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Online brokers began to gain in popularity in the mid-to-late 1990s, facilitated by the development of high-performance computers and faster Internet connections.
Advantages of Using an Online Broker
Online brokers take the personal bias out of the equation, while traditional brokerages are often said to promote a standard package of investments, with some of them even blamed with promoting their partnered mutual funds.
Online trading is convenient, as you can place orders, check quotes and make changes from anywhere. It also facilitates faster execution of traders, helping to take advantage of the volatility in a better manner. Above all else, online trading is more cost-effective compared to trading through a traditional broker.
How Does an Online Broker Work?
Once you key in your order with your online broker and the order is placed in the database, it checks the different markets, including the NYSE, NASDAQ and ECNs, or electronic communication networks, which connect buyers and sellers.
The market that successfully matches the buyer and seller sends a confirmation to the brokers of both parties. The order, and the price at which it is executed, is made available to regulators as well as market participants. Once an order is executed, the exchange sends a contract to the brokers of both the buyer and the seller.
The brokers then do a T+3 settlement, meaning they have 3 days to exchange the cash and the shares. The money due to a seller will automatically be credited to his or her account.
How to Open an Online Broker Account
In order to participate in online trading, you need to open an account with an online broker. The right choice is key here. Once you zero in on a broker, you need to fill an account opening application form and provide documents for identity proof. The various documents/details you may be required to submit at the time of opening an account are:
- Personal information such as name, address and employment details
- Social security number
- Signature card
- W-9 form
- Two documents for proof of identity, including one photo ID
You also need to decide the method for funding your online account, which can be through electronic fund transfer, wire transfer, checks, stock certificates, etc.
Check our picks for the best online brokers for beginners.
Online Broker Fees
Online brokers charge a fee for the services they render, including for their website and infrastructure, relaying orders to the market, settling orders, and more. The brokers may also be charged a fee by the exchanges to use their infrastructure and connect to them, while they may also have to pay for interfacing with the banks for monetary transactions.
- Trading fees:
- This fee is charged on every trade you make.
- Fee for broker-assisted trade:
- In case you need assistance from the broker in the form of advice etc., fee levied will be substantially higher than the regular trading fee for self-directed trades.
- Account maintenance or inactivity fees:
- This is an annual fee charged for maintenance of your account and can range from $20 to $50. It is usually charged when your account balance falls below a minimum.
- Sometimes the broker lends money to the clients for trading. You will be charged interest on the amount loaned by the broker.
- Withdrawal fees:
- Some brokers levy withdrawal fees when you withdraw cash from your account.
Types of Online Brokers
A full-service broker offers a range of services, including trading, investment advice, research, retirement planning, tax tips, etc. Given the wide range of services they offer, the fee involved is relatively high when compared to a discount broker.
However, they serve as one-stop shop for all investment-related services. This category of broker may be apt for a beginner who is just starting out and needs some hand holding and resources to help him make informed investment decisions. Some of the sought-after full-service brokers include Charles Schwab, Fidelity Investments and Merrill Edge.