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Brokerage Account Guide
When you begin to start trading, there are a lot of fundamental questions that brokers and educators don’t answer as clearly as you would like. This is mainly due to the fact that like any other industry, there is money to be made by selling to the newcomer.
A brokerage account is necessary to do any serious trading, although the clarity of where to go isn’t necessarily something that people have. By looking into a few basic questions, you can answer some of the most critical topics when it comes to your newfound trading career.
What is a brokerage account?
Simply put, a brokerage account is a place where you execute orders in a marketplace. In order to place money into a market, you must be able to interface with that market.
The most common example of this would be a brokerage account, where you open up an account to place money in. Then eventually you place an order, perhaps to buy stock in Apple, which gets facilitated through your brokerage account.
They usually charge a small fee to execute that order through the stock exchange be it buy or sell orders. Ultimately, think of it as a way to interface with various markets.
Some brokerage accounts offer the ability to trade multiple markets, which would be extraordinarily difficult to do directly through the exchanges.
Why it makes sense to open a brokerage account
In short, comes down to money. You can become a member of certain exchanges, but it becomes extraordinarily expensive. For example, if you wanted to be a member of the CME, it cost several thousands of dollars.
Beyond that, what happens if you're going to trade stocks as well? You need to then facilitate trading through the stock markets, which of course is going to cost you also.
By opening a brokerage account, you not only have the ability to switch multiple markets. Depending on what the broker offers, but most of the time they are also regulated which means that you get a certain amount of safety through the national or even international regulators with whom you deal with.
In the end, it’s cheaper and much more convenient than trying to open up direct access to the markets.
Brokerage accounts allow you to get a safe way to travel the world of finance. By trying to open up markets on your own, you would be talking about thousands and thousands of dollars, and that’s before you even get started.
Beyond that, you don’t have the same type of protection you have through a brokerage firm. Also, brokerage firms tend to offer extra such as education, news, and classes that are available. Today’s brokerage firms offer a multitude of extras with each account.
What type of brokerage accounts are available?
There are multiple types of brokerage accounts including cash, margin, and some subaccounts like Forex, CFD, or even all-inclusive accounts. With the cash account, you simply have the cash on hand to buy certain securities.
For example, if you have $10,000 in the cash account, you can buy $10,000 worth of stocks, bonds, or other financial securities depending on what is offered.
With the margin account, the broker allows you to buy larger amounts than you have in the account, so the same $10,000 account might be able to be levered up to give you something closer to $50,000 worth of buying power, or perhaps even as high as several hundred thousand dollars in the Forex market.
Margin varies from instrument class to instrument class, country to country, and broker to broker. The problem with margin is that while it can help multiply your gains, it will also help multiply your losses. You simply put up a certain amount of margin to buy the position.
An example might be that you wish to trade in the currency markets. Your broker offers 1:100 leverage, meaning that if you want to trade $100,000 worth of currency, you need to put up $1000 worth of margin.
Once the trade becomes $-1000, you then need to put up more margin. Typically, if you have more money in your account it will simply use that extra cash. However, if you do not have the money in your account most brokers will liquidate you immediately.
The alternative might be what they call a margin call, which was when brokers would call customers demanding that they deposit more money in the past. However, this situation has become automated and you will become liquidated almost immediately under normal circumstances.
There are Forex accounts, which allows you the ability to trade the foreign exchange markets, CFD accounts which are “contract for difference” instruments available to trade and can be made to be almost anything.
There are CFD markets for stocks, commodities, currencies, bonds, cryptocurrencies, and just about anything that you can think of. You are not trading the underlying security, such as a share of AT&T, you are simply betting on the price going up or down.
There are all-inclusive brokerage accounts such as Interactive Brokers, which allow you to trade in multiple assets. There are other brokerages out there that allow this as well, and your mileage may vary so to speak.
With an all-inclusive brokerage account, you may have the ability to trade currencies, stocks in Germany, commodities in Japan, futures in Singapore, and so on. The all-inclusive brokerages tend to be cheaper, but they also tend to have a higher bar to entry, some with larger minimum deposits although Interactive Brokers has recently dropped that.
What is the best brokerage account?
This is one of those questions that will have a unique answer for each person, but the simple answer to this question is probably “the cheapest one.”
This is assuming that you know something about trading, or you are looking to place a longer-term trades and don’t have a need for a lot of bells and whistles. If you are a more experienced trader, or as your experience grows, you may wish to trade multiple markets.
In that sense, the all-inclusive type of brokerage firm tends to be one of the best. Execution costs are typically cheaper, but you will also usually pay for data from the multiple exchanges, which can get expensive depending on how many markets you are talking about.
If you are looking to trade currencies only, then a Forex account is almost always going to be your best option, because they specialize in that market and therefore the execution is much cheaper and of course they tend to offer more in that realm.
If you are looking to trade options, then you may find certain options brokerages have better commission structures to suit your needs. In the end, it’s a unique situation for each person, but you must be aware of your trading costs.
What type of investments can I make?
Each brokerage firm will have a list of financial instruments that you can trade, and it will of course be different with each one. Ultimately, you need to figure out what you want to trade first, and then start looking for the best price.
You will find that as long as the broker can execute your stock trade, currency trade, or whatever it is you’re trying to do, they all start to look the same in the long term. They either execute or they don’t.
As a general rule, the most common markets will be stock markets, options markets, futures markets, CFD markets, bonds, REITs, ETF markets, mutual funds, as well as some less known financial markets that would be considered to be “exotic”, such as currency swaps.
Decide what markets you wish to participate in, then start looking for brokers that offer those markets. After that list is compiled, then start looking for commission structure differences to maximize your profits.
What are the limitations of a brokerage account?
Depending on where you live, there may be a certain amount of pattern day trading questions. If you are in the United States for example, you cannot become a day trader with less than $25,000 in a stock market account.
Other countries have various rules as well. Each brokerage firm will have its minimum deposit, some as low as $500, some even offering an account with no deposit, but at the end that varies too widely to come up with a general rule.
As of late, most brokers have become very aggressive trying to pick up retail clients, so barriers to entries are getting much lower.
Again though, please look at the trading costs involved, because I cannot stress enough how much that can eat into your profit and how much it can cost you over the longer-term.
Cost may not be the most important thing, if you happen to be a “buy-and-hold trader”, or a longer-term investor. However, if you are not, costs are the biggest barrier to profitability beyond your own trading decisions.
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