There’s no straightforward process on how to choose an online trading broker because most of it depends on your personal needs.
You’re likely going to have to compromise on some factors to get the features most important to you. Low commissions might be the most critical factor to you, but you may have to sacrifice on execution quality or software packages.
How to Choose an Online Broker – What Products Do I Trade?
Most brokers tend to have one or two core competencies when it comes to products to trade.
While they may offer a broad suite of products, most of the time, a broker only does a few things well. It would be best if you chose your broker based first on the products you primarily trade and then go from there.
Futures traders might choose something like NinjaTrader Brokerage, or AMP Futures, brokers aimed specifically at futures traders.
Stock traders, on the other hand, have plenty of choices because equities are the most popular retail product, compelling brokers to cater their offerings to stock traders.
What’s My Time Frame?
Some brokers try to be a jack-of-all-trades, while others choose one niche to focus on. Some brokers cater to day traders, investors, options traders, futures traders, algo traders, etc.
Brokers like Lightspeed and Speedtrader cater to highly active day traders. Their main competitive advantage is in their names: speed. They provide direct market access and low-latency trading platforms built for day traders. It wouldn’t make sense for an investor or options trader to trade with these brokers
What to look for in a day trading broker:
Direct market access
Commission discounts for high volume
Ability to borrow hard-to-borrow stocks
A trading platform built specifically for day trading
There’s a big question that you need to ask yourself before picking a broker for day trading and that is: will you have enough capital to meet the PDT (pattern day trader) requirements?
According to the PDT rule, you need at least $25k to day trade with a US based broker. If you don’t have that much capital then you will only be able to day trade 3 times in a 5 business day period.
If that is a problem for you then you could look at trading with an offshore broker like TradeZero or CMEG.
Brokers like Tastyworks and TD Ameritrade offer specific analytics and commission pricing to the options trader. I’ve heard TastyWorks’ platform described as being “designed by options traders who know how to code, rather than by coders being told what to do by options traders.”
What to look for in an options broker:
Intuitive options platform (Tastyworks is the retail standard)
Commission caps for spreads with many contracts
Swing traders have plenty of choices because they generally don’t require exceptional executions or a sophisticated trading platform. A broker like TD Ameritrade with their Thinkorswim software and free commissions seems like an excellent fit for most swing traders.
Things swing traders should look for in a broker:
Trading platform with a robust screener and charting platform
Reasonable margin rates
In October 2019, the brokerage industry responded to a demand created by Robinhood when most of the major discount brokers cut their commissions to zero. Since then, the subject of stock trading commissions has mostly died out, but the conversation is more important than ever for highly active traders.
Free commissions are a case of “if it’s free, you’re not a customer, you’re the product.” As you may have read, the reason discount brokers can offer you free trades is that they are paid by high-frequency trading firms to give them the first right of refusal to interact with your order flow. This practice is known as payment for order flow.
This isn’t a huge problem for non-day traders. You are basically paying the spread, which is relatively inconsequential as you move onto hourly and daily time frames.
However, if you’re an active trader who trades on a short time-frame, having your orders internalized by an HFT firm will cut into your expected value and keep you out of certain trades.
For this reason, having direct market access is crucial. Most direct access brokers charge traders on a per-share basis, rather than a flat rate per trade. This presents problems when trading penny stocks
Active trading brokers offer significant volume discounts, usually measuring your volume in the number of shares you trade per month. With this in mind, it’s crucial to project your average monthly volume and find the broker that offers the best rates for your level of activity.
Options and Futures
For options and futures traders, things get simpler. Most brokers charge a per-contract rate for options and futures, making it easy to shop around.
There is still a high level of payment for order flow in the options markets, requiring highly active options traders to get a direct access options broker. Still, the practice isn’t prominent in the futures market due to the consolidation of futures exchanges.
Some brokers, like Interactive Brokers and Vanguard, will charge you monthly account maintenance fees, which can often be waived through trading activity or depositing more cash. It would help if you considered how much capital you intend to deposit, and how often you intend to trade before signing up with a broker who charges monthly account fees.
Most day-trading-focused brokers like Lightspeed and Speedtrader charge a monthly fee for access to their advanced trading platform. The price is usually between $100 and $200, which can be significant for those with small accounts.
If trading with a small account, it’s probably best to consider less active strategies that don’t require a specialized broker who will charge higher fees
Many brokers will offer a free data feed, but that data will often be Level 1 data from just one exchange. If you’re a serious trader, you’re probably going to need to pay for premium data. As a retail trader, you’re designated as a “non-professional” by data feed brokers, so the fees generally aren’t that prohibitive, but they’re something to consider.
The major discount brokers usually offer free data feeds, but the specialized brokers will tend to charge you for the premium data.
Direct Market Access
Having direct market access as a day trader is crucial. This means being able to route your orders directly to the exchanges, rather than routing orders to your broker for them to decide where it goes.
Most of the time, brokers who don’t offer direct market access are sending your orders to an HFT firm who will either scalp your orders for sub-pennies or “lean on your quote.”
Having direct market access means being able to choose between several trading venues to route your order to. Each of these venues will have their perks and drawbacks. Some will pay you to add liquidity (submit an order that doesn’t immediately get filled), others will pay you to take liquidity.
Depending on your trading strategy, it might be essential to have access to a variety of routes, or trading venues. Each exchange is structured slightly differently with different incentives.
The most basic differentiation between routes is their maker/taker fees and rebates. The traditional maker/taker model pays market makers a rebate and charges liquidity takers a fee. However, as the exchange industry became fragmented, there are now venues that charge you for providing liquidity and incentivize you to take liquidity.
Payment for Order Flow
If your broker doesn’t offer direct market access, there’s a good chance they’re receiving payment for order flow. This means they’re paid to route client orders to HFT firms before being sent to an exchange so the HFTs can try to interact with the uninformed order flow profitably.
Your broker selling order flow isn’t necessarily a disqualifying characteristic; your time-frame matters. If you’re a short-term trader trying to capitalize on small movements, you require direct access to ensure you can get the best fills. Still, as expand your time horizon into swing trading, it begins to make sense to trade with a commission-free broker who will sell your orders. “Crossing the spread” doesn’t really matter to swing traders who are trying to capitalize on more significant price moves.
How Much Technology Do I Need?
Consider how complex your trading strategy is, and which types of software (if any) can help you in your implementation of that strategy.
If you have a rules-based trading system, you’ll probably want to backtest that system at a certain point. Sure, you can purchase third-party backtesting software, but if you’re going to backtest regularly, why not trade with a broker who offers the software for free?
TradeStation is considered the industry standard among active traders for backtesting technical analysis systems. It’s Linda Bradford Raschke’s preferred backtesting tool.
It’s also worth mentioning that there are levels of backtesting. Most stock traders are looking for portfolio backtesting, which creates a portfolio based on criteria and measures the historical performance. As opposed to backtesting software which tests your strategy on just one security.
Most traders open their brokerage just as their learning about trading (i.e., the worst time to begin trading with real money). As a result, they tend to lose a bunch of money in the first few months before either A) taking some time away from the market to create a rigorous trading strategy, or B) quitting.
Many brokers offer free trading simulators, which give you a portfolio of something like $100,000 in play money to trade with. The only difference being that a play money account can’t accurately predict the likelihood that you’ll get filled on your trades.
With a trading simulator, a disciplined novice trader can try out different strategies until they find something that is both profitable and suited to their personality.
Brokers that offer trading simulators:
Intraday Stock Scanners
Most brokers offer stock screeners and scanners within their trading platform, but these scanners range in their utility to day traders. Some, like Thinkorswim’s Stock Hacker, have a proprietary scripting language, allowing you to combine filters in several different ways, while others pretty much allow you to look at the day’s gainers and losers.
It would be best if you considered how important a stock scanner being built-in to your trading platform is. Many day traders have a preferred scanner, like Trade-Ideas, that they pay a third-party for each month.
The discount brokerage industry has highly varying margin rates, so much so that, when trading a large account, reducing your margin rates can add several thousand dollars per year to your bottom line.
If you trade on margin often, this can be the most crucial aspect of picking a broker, as it makes a tangible difference in your bottom line.
Here’s a table of popular discount brokers and their highest margin rate (the rate they charge for borrowing the smallest amount of capital)
Depending on your trading strategy, your broker can be the difference between a green and red P&L for the day. Qualitative factors like your preference for their trading platform can have a similar impact as quantitative factors like transaction cost analysis.
Many will begin intermittently depositing cash into their brokerage accounts from their paychecks and reach a point where they feel locked into one broker.
The only way to avoid this is to begin by spreading your money across a few brokers that cater to your interests.