How to select a stock broker

In almost all of my articles, I’ve primarily focused on the risk part of any stock market investment, trading or transaction. Along with that, I’ve also touched the transaction costs associated with a stock buy or stock sell that you do, a mutual fund investment that you make or exit, a forex currency trading transaction or insurance policy – everything comes at a cost. You cannot ignore the effect of transaction costs in any transaction related to investments, trading or insurance purchase.

Now all these things related to transaction costs depend upon the stock broker that you deal with or the insurance agent whom you involve in or the mutual fund advisor or mutual fund investment agent that you consult. Hence, it becomes very very important for you to know about the charges they take and what you should keep in mind while selecting a stock broker

In this article, I will list some of the tips and points that one should keep in mind while selecting a stock broker or an insurance agent or a mutual fund advisor. Questions covered are: How to select a stock broker, tips for selecting a stock broker, transaction charges of a stock broker, questions to ask to a stock broker, etc.

Begin with a simple example. Let’s say my broker charges me 1% for each transaction. Fine with me, I don’t care, I heard from a friend that this broker is good, so I’ll go with him, I’ll pay high for good services, etc. etc.

If I buy stock worth 10,000, then the actual buy stock price to me will be 10,000 + 1% of 10,000 = 10,100. Now suppose I’m lucky that the stock I bought went up by 5% and hence stock purchase is now worth 10,500 and I sell stocks to realize my profit. I will have to again pay 1% of brokerage, which on 10,500 will come to 105 Rs. Hence, I will get a net 10,500 – 105 = 10,395!

So on total investment of 10,100, I made 10,395, a net percentage return of (10,395-10,100)/10,100 = 2.92%. Now remember that the stock went up by 5%, then you were able to make only 2.92%. What you’ve paid to the broker is 2.02%. Hence, even without investing a penny, the broker has made 2.02% profit, that too without any risk.

However, we will not be worried about the broker. Let us only concentrate on our profits. Suppose instead of charging 1%, my broker charges only 0.5% brokerage. Hence, the 10,000 stock investment will cost me 10,050 and when it rises by same 5%, it will give me net 10,500 – (0.5% of 10,500) = 10,447.5. Calculating the return on investment of 10,050, it comes to 3.96%.

As you can observe, my returns have effectively increased by more than 1%. Not only that, my total investment amount is also less, 10,050 compared to 10,100.

Hence, when you keep on trading frequently, the % brokerage you pay significantly affects your profits. The markets are efficient; hence one needs to know how to trade within short spreads. It was easy for me to assume 5% increase in stock price, but do we see it always? No.

Selecting a broker therefore is an important aspect of trading and investment – be it for short term trading, long term investment, mutual fund unit purchase or any financial instruments.

• It must have online trading facility:
In the present mobile world, it is now almost impossible to be with a broker who does not have online presence and online trading account facility. I may be in New York, Tokyo or Sydney, but I may be trading in the Singapore stock markets. Hence, having online trading facility is very important

• Off market order placement facility
If I am in New York in a different time zone and want to trade in Indian Markets, I do not need to keep awake all night to place my orders. My broker should allow me to place trade orders for selling & buying stocks anytime during the day

• Depot and nostro facility

One of the most important things that you need to know is whether the broker offers both Depot and Nostro services. Depot means your demat account where you keep your shares. Nostro means your bank account where you keep your money for buy and sell of shares. Both are important as you need money as well as shares to keep trading or buying for long or short term. Hence, a stock broker that offers you both depot as well as nostro is the best bet. The reason is that the money movement does not take much time.
However, it all comes at a big cost.

• Transaction charges:
As illustrated above with the numbers, you should know how much your broker will charge. If you are not clear of the charges, you will be on a loosing side, as majority of the profits will be given to the broker as brokerage

Continue to part II of this article