Most of my readers, like me,  approach trading from a retail perspective.  A “retail trader” is a person that executes trades through a broker.  The alternative is an “institutional trader” – someone who is part of a company that has their own exchange memberships and clearing ability and thus can function as their own broker.  So if you’re going to operate as a conventional retail trader, you need a broker.  And it turns out that choosing a broker is very complicated.  What makes it worse is that you have to choose a broker before you can gain any real trading experience.  So traders are at the most ignorant point in their careers when they have to make this important decision.  I’m going to walk you through some aspect of the process, and hopefully at the end you’ll know enough to proceed.

Before we go any farther, I need to be clear: all my trading experience is in the US.  I have no idea what the brokerage situation looks like in other countries so I can’t provide advice there. You’ll have to find a local expert.

While I am not a big fan of Elite Trader, their list of brokers with reviews is fairly useful.  The number of reviews for a given broker will tell you which ones are heavily used.  Start your research there, at least to get a list of names to look at.  Then consider the following issues:

Are They Really A Broker?

The first thing you need to determine is whether or not your would-be broker is in fact a legal broker in the United States.  You can use FINRA’s broker check website to find out.

This is important because there are lots of fly by night firms that look like brokers, but in fact are not.  What they are is “proprietary trading” firms (often called prop firms for short) where instead of depositing money with a broker, you’re buying into a partnership or other corporate structure and then trading for them.  Many of these firms offer apparently excellent commissions structures and leverage.  Unfortunately, history has shown the vast majority of them to be scams.  There are some legitimate ones, but they are few and far between.  In general if a prop firm asks you to put up capital or pay money for training, they’re not legit.  Most of the legitimate ones pay a conventional salary and pay for training and are very selective about who they hire.

As a general rule, never pay money to buy into a prop firm or purchase training unless you are VERY experienced in the industry and know exactly what you’re doing.

Product/Market Selection

A broker is only useful if they give you access to the market(s) you want to trade.  In the US nearly all brokers provide access to the NYSE and NASDAQ electronic stock markets.  Beyond that, it can vary widely.  Personally I like to have access to a full range of US products, but I don’t care so much about foreign ones.  Other people may have different needs.  I would want any broker I used to have the following exchanges at a minimum:

• The NASDAQ/ISLAND and NYSE/ARCA electronic stock exchanges
• CBOT stock options on the GLOBEX exchange
• CME/COMEX/NYMEX futures on GLOBEX
• some sort of foreign exchange (FX) access
• some sort of spot bond market access

Note that everything but the straight stocks and bonds basically requires that you have a margin account, although some brokers will allow purchasing options or writing covered options positions that have a bounded maximum loss without one.

Commissions

This is where things get weird.  Exchanges charge the brokers a fee (or in some cases provide a rebate) proportional to trade size.  A typical fee might be $0.003 per share.  This is the majority of the costs your broker incurs when you trade through them.  You can see the NYSE/ARCA fee structure here.

Based in that, you would think brokers would charge a variable fee that tacked extra for expenses and profit on top of what the exchanges charge.  But this isn’t the case at most brokers – most of them charge a flat fee for stock transactions in the $5-10 range.  The impact of the flat fee is that the brokers horribly overcharge some customers and opperate at a loss with others.  In general, small customers and those providing liquidity (who would qualify for exchange rebates) get overcharged, and big liquidity consuming customers get undercharged.

There are some brokers with a more transparent fee structure – Interactive Brokers for example has a base commission structure where they charge a flat $0.005 per share, minimum one dollar.  This still isn’t fully transparent, but it’s better.  They also offer an alternate “cost plus” model where exchange costs/rebates are fully exposed to the customer.  Cost plus only becomes a good deal when you have slightly larger volumes or trade in a way that generates a lot of rebates though.

Picking a broker with a favorable pricing model is important.  For example, if you were executing the speculative alternatives portfolio with $30K of capital at Interactive Brokers, most of your commissions would be $1.  At E*Trade they would be $9.99.  Since we started tracking it, the account has made 33 trades and earned $1850 or so in profit with IB commissions   Move the account the E*Trade and you’d be about $300 poorer.  That wouldn’t totally wipe out your profits, but it would hurt.  It’s basically not feasible to trade the speculative alternatives portfolio at a conventional discount broker.

The flip side is if you had a large account and placed lots of big liquidity consuming orders.  For example, buying 10,000 shares of INTC at Interactive Brokers would cost you $50 of which $30 or so would be exchange fees.  But if you did that trade at E*Trade, you’d be charged $10 and they’d eat the extra $20 of fees.  So you could actually come out ahead.  E*Trade is just gambling that most of their customers will be too small to take advantage of the situation.

In general active traders are better off with a variable fee structure. You’ll just have to go read the various brokers’ websites and figure out what will be best for the trades you want to do.

Financial Stability & Insurance

It really sucks if your broker goes bankrupt on you.  At best, you will eventually get money back from SIPC or the bankruptcy settlement.  How much you get depends on what positions you held and/or the terms of the bankruptcy.  But it’s MUCH better not to have that happen in the first place.  You should read the above linked article for details on how to avoid the problem – it’s too long to repeat here.

One thing I forgot to mention in that article is that you should determine who clears trades for your broker if they’re not self clearing.  You’re also exposed to that firm failing.  The same diligence that allies to brokers applies to clearing firms.

Support, Broker Help & Branch Offices

If you’re a more novice trader or just like doing business in person, it’s nice for your broker to have a nearby branch office.  It’s not essential though.

Minimum Deposit, Margin, Lending Rates & Stocks Available To Short

When you open a margin account with a broker, you’re in essence entereing into a credit relationship with them.  Those relationships have radically different terms.  You need to know:

• How much does if cost to borrow money to buy securities on margin?
• Is interest paid on the proceeds from short sales?  If so, how much?
• What’s the minimum deposit to open an account?  How much is required to keep it open?
• What’s the margin call policy?
• Does the broker offer margin or a reduction in performance bond beyond Reg T or CME limits during the day?
• What does the supply of stocks available to short look like?
• Is portfolio margin offered, and if so how big an account is required to get it?

Software Features

Brokers always have some sort of default software package you use to enter trades and access market data.  These packages vary widely in features and quality.  Figure out if they support the things you want.  If not, you may have to consider 3rd party software add-ons (see below).

Demo Support

This could be considered a software feature I suppose, but it’s very important that your broker supports a demo or paper trading mode, especially if your intent is to trade on short time frames.  This gives you the opportunity to practice trading at no cost.  In addition, if you’re planning to use third party trade execution software, demo mode is essential for debugging.

Third Party & Custom Software Support

If you find your broker software inadequate (and most traders eventually do) you’ll probably want to add third party packages.  Ninja Trader and Trade Station are the two most popular, but there are many others.  These packages do trade automation, charting & analysis, allow the coding of custom indicators etc.  Be aware that many packages have deals with brokerages, so it’s no always clear whether they can be run stand alone.  You just have to do research.

The first question you should consider is whether your broker supports these packages by allowing access via an external software API (either FIX or proprietary) .  Some do, most don’t.  In general it’s good to use a broker that provides an API – otherwise if you later decide you want to use 3rd party software you may be stuck and have to change brokers.

Data Feed Type, Cost & Quality

If you’re going to actively trade a given financial instrument, you need good data about it.  There are several pieces you are probably going to want:

• Top of book/level 1 price data:  This data tells you the current bid and current ask and their associated sizes in shares/contracts.  This is the bare minimum data you need to enter a trade.
• Time & sales/tick/tape data:  This data provides a running “tape” of all transactions and top of book changes in real time.  It’s also nice to be able to get historic tape data so you can go back and see what happened in the past.  This is the data you need to display a meaningful ticker for an instrument, and should also be considered mandatory.
• Depth of book/level 2 price data:  This is data about the order book some distance away from the current top of book.  This allows you to see how many orders are waiting in the wings or how much a big order will move the price.  This data is not essential unless you’re trading a strategy that requires it or are trading large size and will be moving the market.  Then you need it.
• Historic bar data: This is data about historic price ranges over some period of time, denoted as a “bar”.  Short bars can be aggregated to create longer ones.  Data varies by the bar granularity and how far back it goes.

Also be aware that data is not of uniform quality.  There can be errors, which is hard to know before you sign up.  But errors are very problematic for automated systems, so if you’re planning to do automated trading you should pay close attention once you open an account.

You should investigate what your would-be broker offers and how much they charge.

The Importance Of A Good Internet Connection & Computer

This isn’t directly related to your choice of broker, but it is very important to your overall brokerage experience.  Your brokerage software won’t work very well if the internet connection to your broker is unreliable or if your trading computer isn’t up to snuff.  The more you use 3rd party software to execute complicated strategies or compute mathematically intensive indicators, the more important it becomes that your computer is fast.

If you use monitors to display charts in real time, it’s very useful to have a multi-monitor setup.  Two 27″ 1080P monitors works well for me and can be had cheaply.

Recommended Setups

• Investor or low frequency stock trader: commissions here aren’t that big of a deal, so I wouldn’t go overboard looking for the lowest rate.  I would look at Scottrade, TD Ameritrade and E*Trade and figure out who has the most conveniently located branch office near you, and go with them.  If more than one is close, I would probably choose TD Ameritrade.  They seem to have very good service and perfectly acceptable features for this class of trader.
• Cheap active trader: This is the category of setup you would want for executing strategies like the speculative alternatives portfolio   Here I would use an Interactive Brokers margin account with their basic data package and no additional add-on software.  If you used this account for just the speculative alternatives portfolio, you would not generate enough commissions to waive the $10/month basic market data fee.  But even with that fee still way better than overpaying for individual stock trades.
• Moderate priced active trader: This is where I find myself now – I want some nice features that Interactive Brokers doesn’t provide naively, but I can’t afford to pay thousands of dollars a month for a really high end setup.  So I add an external trading software package and a 3rd party data feed.  Here’s the whole setup:
  • Computer: home built i7 8GB RAM system with 2 500GB disks RAID mirrored for reliability.  Two 27″ 1080P monitors.  Backup is an external USB drive.
  • Brokerage: Interactive Brokers margin account
  • Trading Platform: Ninja Trader 7 connected via the IB trading API.  This cost $750 one time fee.
  • Data Service: Kinetic unfiltered futures data – ~$50 per month after the CME/GLOBEX exchange rebate program.  IB’s market data via the API is an filtered backup and covers everything, giving me arguably the best of both worlds.

One more bit of advice: you are NOT tied to a broker once you send them money.  If your broker isn’t delivering a quality of service you’re comfortable with, or you just get a bad vibe, take your money out and go elsewhere.  Bad service is frequently a sign of impending broker failure anyways.

Full disclosure: I was not compensated in any way for the recommendations in this post.