Before you can trade stocks online, you have to select an online broker. Your online broker will execute your trades and store your money and stock in an account. The online trading industry has seen lots of mergers and acquisitions, but there are still many firms to choose from. Different firms also offer different levels of help, account types and other services. Here are some things you should keep in mind as you look for a broker.
| E*Trade, Ameritrade and Charles Schwab are three of the many online brokerages. |
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How much money you plan to invest. Most firms require investors to have a certain amount of money to open an account. This is different from a minimum account balance -- although most brokerages have those, too.
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How frequently you plan to make trades. Are you going to buy one stock and hold on to it? If so, you'll need to make sure the brokerage doesn't charge a fee for account inactivity. On the other hand, if you're going to make lots of trades, you'll want a lower fee per trade. Regardless of how much you plan to use your account, you should evaluate how much using the site will cost you.
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Your level of trading experience and how much guidance you need. Some of the least expensive brokerages don't offer much in the way of research or broker-assisted trades. Others, while still moderately priced, offer market analysis, articles on successful trading and help from licensed brokers.
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Any other services you may want. A few trading sites let you buy and sell stocks but not much else. Others are more like major banks, offering debit cards, mortgage loans and opportunities for other investments like bonds and futures.
Some sites, such as Keynote and Smartmoney, rate online brokerages based on success rates, customer service response time, trading tools and other factors. They can help you make a decision as you shop around for the best trading site for your needs, but keep in mind that there are no official standards for ranking or evaluating brokerages.
As with any site that requires your personal and financial information, you should make sure your online broker has good security measures, including automatic logouts and transmission encryption. You should also make sure your brokerage is reputable. The Investing Online Resource Center has a good list of links you can use to make sure your firm is legitimate.
Opening & Funding an Account
When you open an account with a United States online brokerage, you'll answer questions about your investment and financial history. These questions determine your suitability for the account you are requesting -- the brokerage cannot legally allow you access to investments that you cannot reasonably handle. You will also have to provide your address, telephone number, social security number and other personal information. This helps the brokerage track and report your investments according to tax regulations and the PATRIOT Act.
In addition to providing this information, you must make several choices when you create an account. With most brokerages, you can chose between individual and joint accounts, just like at a bank. You can also open custodial accounts for your children or retirement accounts, which are often tax-deferred. Unless you pay a penalty, you can usually retrieve earnings from a retirement account only when you retire.
Next, you must choose between a cash account and a margin account. You can think of a cash account as a straightforward checking account. If you want to buy something using your checking account, you have to have enough money in the account to pay for it. Using a cash account, you have to have enough money to pay for the stock you want.
A margin account, on the other hand, is more like a loan or a line of credit. In addition to the actual cash in the account, you can borrow money from the brokerage based on the equity of the stock you already own, using that stock as collateral. Then, you can buy additional stock. Your margin is the equity you build in your account.
According to the Federal Reserve Board, you must have at least 50 percent of the price of the stock you wish to purchase in your account. In other words, if you want to purchase $5,000 worth of stock, the value of the cash and stock in your account must be at least $2,500. You can borrow the other $2,500 from the brokerage.
Once you have made your purchase, you must keep enough equity in your account, also called your equity percentage, to cover at least 25 percent of the securities you have purchased. Here's how the brokerage determines this number:
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The market value of your stock minus the amount of the loan you took to buy the stock is your equity amount.
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Your equity amount divided by your total account value is your equity percentage.
If your equity percentage falls below the minimum, the broker has the right to issue an equity call. Typically, the brokerage will try to contact you, but the firm has the right to sell any and all of your assets to raise your equity percentage to the minimum. The brokerage is not obligated to contact you.
Margin accounts are definitely more complex than cash accounts, and buying on credit presents additional financial risks. If all of that sounds overwhelming, it's a good idea to stick with a cash account. If you'd like some more examples of how margin accounts work, check out the IORC's Investing Simulator Center.
Finally, you must decide how the brokerage will store your money between trades. Many brokerages offer interest-bearing accounts, so you continue to earn money even when you are not trading.
Once you have made all these choices, you must fund your account. You can make a deposit by check, make a wire transfer to the brokerage or transfer holdings from another brokerage.
