The importance of choosing the right stock broker

A quick google search will return a plethora of stock broker services, from both local providers and international. The access to a diverse range of brokers has increased since the proliferation of online services; so how does one go about choosing the right broker for their needs?

The most important factor is one of best execution of a trade. Best execution involves a number of elements apart from the simple fixed transaction fees. The default nature of consumer investors is to select the platform or service with the lowest commissions. It is no secret that there are an increasing number of platforms that offer equity trades with zero commissions.

Now think for a second how it’s possible that a profit seeking company in a business that revolves around brokerage fees can survive long term without actually charging anything. The answer is in the price that is actually delivered to customers. Commission free retail platforms mostly use wholesale market making firms in their execution as opposed to having on-exchange access.

Indeed typically their menu of investing options are much more restricted when compared to top tier brokerages.

Wholesale market makers are large broker-dealer firms that trade using their own capital. Market makers offer to buy and sell stocks and make money on the spread – the difference between their purchase price and sale price.

What this means is that what you “save” on commissions on the other hand means that you may not necessarily get the best available price on the market. This is known as slippage. Slippage involves a number of additional factors also.

The execution cost is impacted by delays in delivering the order to market, the market impact of executing the trade and also the opportunity cost of any unfilled part of the order.

Therefore, it is fundamental that you select a broker that has low downtime on its platform due to technical issues, is easy to use, a broker that has direct access to the market, known as “lit venues” as well as other dark pools where large institutional orders are typically transacted in order to minimize market impact.

Indeed, top tier execution venues nowadays use algorithms to determine the best execution price for the client from its network of lit venues and dark pools. This practice is not put in use by commission fee brokerages as their business model revolves around getting a commission from channelling order flow to market makers.

The aforementioned market impact cost of the trade is an often overlooked aspect of trade execution, which for large orders or retail orders in thinly traded markets such as the Malta Stock Exchange often takes on the largest proportion of the total execution cost of the trade. Indeed, the less liquid a market is the more important it becomes that you select the correct execution venue.

Most international bonds for example do not trade on regulated exchanges, they are traded via broker dealers. In order to obtain the best available price, it is fundamental that your broker has access to a network of top tier dealers typically through what are called multi-lateral trading facilities. This is especially true for high yield bonds, which have higher bid/ask spreads than investment grade bonds.

This discussion strictly relates to best execution which remains the primary consideration. Secondary considerations include whether the broker offers research, and the quality thereof, as well as portfolio management services which on some platforms offer robot-advisory services for those that are comfortable enough to make use of them. Service considerations such as customer care quality and other related account charges such as custody fees, deposit fees and any other layered fees needs to also form part of your decision making process as everything adds up.

Finally, a key consideration which is often overlooked, and is directly related to the execution cost is the spread charged on foreign exchange transactions. Often we require to invest in foreign currency assets. Having a broker that charges low commissions, however charges excessive spreads on forex is counterproductive when considering the total fixed costs of a transaction.