money on commissions for the exchange of stocks. If they have no transactions during a given month, they don’t get paid. Unscrupulous brokers recommend trades to their customers to generate new commissions even when those decisions are not necessarily the best investment advice for their clients. This practice is often referred to as churning.
Even the research arms of many full‐service brokerage houses are scrutinized by the Securities and Exchange Commission (SEC) primarily because their analyses didn’t accurately reflect the values of stocks in companies that used the firms’ investment‐banking capabilities in the past. Analysts tend to see their firms’ clients through rose‐colored glasses when providing research reports, especially when their firms make a lot of money by providing investment‐banking services to those companies. We talk about changes that have been implemented to improve analyst services in Chapter 7.
Many discount brokers offer the same services as full‐service brokers, including research. The big exception is that you don’t get individual attention or unsolicited advice on what to buy or sell. Some discount brokers send out monthly newsletters with stock recommendations; most don’t trade futures or sell variable annuities. You can access a discount broker by telephone, mail, fax, or Internet. To get the lowest fees on trades, you need to do your own trades by accessing the broker’s website.
The big difference to you, as an individual trader, is that you can save a lot of money on trading costs, provided you know what you’re doing and you understand the language of stock trading. Transaction fees for online trades can range from as low as $5 up to about $30 with a discount broker. If you want special services requiring a broker’s assistance, you can work with a human being. Depending on the discount brokerage firm and the level of service required, fees can range from $25 to $50 per trade. Some discount brokers provide broker‐assisted trades using a commission rate schedule similar to the ones offered by full‐service brokers, but it has lower fees per trade. If you get involved in more‐complicated trading transactions that require human assistance, costs can rise significantly. Anytime you’re planning to use a broker’s assistance, be sure you understand any additional costs that may be charged to your account for that assistance.
If you want to bypass the traditional brokers and trade directly through an exchange or market maker, you need to open your account with a direct‐access broker so you can use one or more of the electronic communications networks (ECNs) to make your trades. Traders usually download software onto their PCs so they can access the ECN directly using their Internet connections.
Traders using direct‐access brokers typically get real‐time NASDAQ Level I quotes, which show the latest bid and ask prices, quote size, last trade, and volume.
Direct‐access brokers also offer NASDAQ Level II access. NASDAQ fees are higher for Level II, and the brokerage may also charge an additional fee for this type of access. In addition to what you see in a Level I quote, you also find the number of market makers participating in the market for any one stock.
A NASDAQ Level II quote screen shows the best bid price and the best ask price for specific stocks from participating market makers. All the bid and ask prices are ranked from best to worst. Some direct‐access brokers combine NASDAQ Level II information and ECN book data to show the complete market depth for a specific stock. The ECN book isn’t a printed book like you would expect to find on a bookstore shelf. It’s a compilation of all the trades and the bid and ask quotes available on all the electronic networks.
Traders can review the quotes and select which market maker or ECN to use for each transaction. Most full‐service and discount brokers make that choice for you when you’re working with them. A few discount brokers are providing access to ECNs.
Working with a direct‐access broker gives you a steady stream of raw financial data – the actual trades, current bid and ask prices, trading volume, and market statistics. The trading software that you load onto your computer determines how this data is organized and presented on your computer monitor. Providing better access is how direct‐access brokers distinguish their services from other brokers.
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