How to choose the right online broker

Choosing the right broker is an important step for any successful trader, but it’s also one of the most frequently overlooked. Many people simply plump for one of the big names, without stopping to check whether the services these offer are the most suitable for their purposes.

For instance, the ideal firm for a pension account – where you might only trade a few times a year – will often be unsuitable for a trading account where you deal far more frequently. If you plan to be an active investor, it’s crucial to ensure you avoid unnecessary costs, while also making sure that you get good service and efficient execution on your trades.

So what should you take into account? You might be tempted to base your choice of broker on their dealing commissions, such as low headline dealing rates or discounts if you trade frequently.

This is important, but you should check the firm’s other charges. Firms may try to catch investors out by luring them in with cheap dealing fees, while inflating less-obvious charges to compensate. Excessive commissions on foreign currency are popular, so it’s particularly important to take account of these if you plan to deal in stocks that are not priced in sterling.

You should also look into the quality of service that the firm offers. Take into account issues such as the stability of the firm’s trading platform. It’s important to know if the site will function when you need it most, or if it has a history of crashing in times of turmoil. Assess the brokers’s reputation for customer service issues, such as timely processing of dividends and their efficiency in resolving problems.

One simple way to research other investors’ practical experiences with a broker is to read online investing forums. However, it is worth bearing in mind that disgruntled users are more likely to complain about problems than happy clients are to say that all has gone well.

If you’re thinking of trading in securities such as Aim-listed stocks, preference shares and retail bonds, make sure that the broker trades in these – not all do. Also consider whether you will make regular use of limit orders and stop orders (an order to buy or sell a stock if the price reaches a certain level) – these can be useful when dealing in less liquid securities. If so, check how the broker implements these: there can be some differences between brokers in terms of how flexible these order types are.

Look into the security of your broker. Is it financially solid? Will it still be around in a year’s time? You should only deal with firms authorised and regulated by the Financial Conduct Authority and that are members of the Financial Services Compensation Scheme (FSCS), which compensates up to £50,000 per client if a broker collapses and your money or assets go missing due to fraud and negligence. Never deal with unregulated firms that cold call with tempting offers – these are scams.

However, don’t ignore smaller, independent brokers, so long as they’re properly regulated and covered by the FSCS. They may sometimes offer a more flexible, cost-effective and helpful service than the big names.

Understanding direct market access

UK stockbrokers use two different approaches for executing trades. While the difference doesn’t matter much if you’re a long-term investor, it can have quite an impact for active  short-term traders aiming to get the best price on every trade.

The first and most widely used is a “quote-driven” system. When you place a trade, your broker contacts a selection of market markers (known as retail service providers or RSPs), who are dealers who undertake to buy or sell a stock at specified prices at all times. Your broker polls a pool of RSPs and the quote you receive is the best price from any member of the pool. Each broker has a different network of RSPs – sometimes as many as 30 – but a larger network doesn’t necessarily mean you’ll receive a better price.

The price you receive is valid for a limited time period – generally 15 seconds – in which you can decide if you want to accept the price. If you don’t, the price lapses and the trade is cancelled. If you accept the price, your trade proceeds. It’s important to note that it doesn’t go through the London Stock Exchange – you’re buying or selling to the RSP with the best quote.

The second is an “order-driven” system called “direct market access” (DMA). This means your order is placed onto the exchange’s order book and remains there until it’s cancelled or somebody accepts the price you offer. If you often trade stocks where the RSPs quote a large bid/offer spread (the difference between the price at which you can buy and the price at which you can sell), using DMA lets you offer your own price within the spread, which could allow you to execute the trade at a significantly better price than the RSPs are offering. (Unfortunately DMA is not available for many Aim stocks, which suffer from wide spreads.) DMA also allows you to place orders during the auctions before trading opens and after it closes, which can produce attractive trading opportunities.

While DMA is used for almost all trades in some countries, UK private investors rarely use it – partly because only a few retail providers offer the service. However, if DMA appeals to you, providers include iDealing, IG, Interactive Brokers, and Saxo Capital Markets.

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