Why the price increase at OptionsHouse?

Have you wondered why OptionsHouse recently increased its stock trading commissions from $2.95 to $3.95 per trade for all new customers? (Previous customers still get the low $2.95 commission.)

At BrokerInsider, we have some special insights. If you’ve ever worked at an online brokerage, you should know that a commission increase is a very scary thing, because it is easy to get bad press or lose existing customers. The worst part, however, is that your customer acquisition might slow to a trickle — and there is no way to model this in advance.

But OptionsHouse must have done it for two reasons:

First, low commissions make profitability very difficult. While it may seem like the history of stock commissions is one of constant price reduction, they can’t actually fall forever. Stock trades do have a cost — about $1 per trade on the wholesale market — and a $2 profit isn’t very much unless you have incredible volume. OptionsHouse’s profit is probably a little higher because they are a subsidiary of PEAK6 Investments, but not much.

Second, low prices don’t attract many new customers. The difference between $8.95 (which is what you’d pay at Schwab) and OptionsHouse’s new $3.95 commission is just not that high, especially for casual traders. And if price were everything, OptionsHouse (or before them, Zecco) should have claimed the whole market. It turns out online brokerage customers just don’t move that quickly. More likely, they get used to the interface of a brokerage and are loath to move unless something really bad happens.

In summary, this is price increase is not so surprising, and we predict other brokers will follow suit.  If there’s any advice we have, it’s sign up for your new discount broker now, because brokerages are highly likely to grandfather low pricing for customers who joined before the commission increase.

Mutual funds vs ETFs: Which are cheaper? (Part 2)

In Part 1 of this series, I pointed out the ETFs do generally have lower expense ratios that mutual funds. But there is a second, less visible cost to ETFs: the bid-ask spread.

ETFs trade on an exchange just like a stock. This means to buy one, somebody else has to sell one, and sellers never ask for a price that is exactly market value. They always ask for a price that’s just a bit higher, and that’s called the “ask” price. And the ask price is what you pay.

This difference in price between the market value and the buying or selling price is called the bid-ask spread.  In general, this price difference is small — less than a penny — because people are buying and selling a lot of the most popular ETFs. Another way of saying this is that these ETFs have high liquidity.

However, if you are trading unusual ETFs with low quantities of buyers and sellers, the bid-ask spread may be very wide.  The bid-ask spread may also be wide if the component stocks of the ETFs have low liquidity, because the market makers have to incur costs to create new ETFs on the fly.

So what should you do? Just make sure that the bid-ask spread is low as a percentage of any ETFs you buy. Bloomberg Businessweek has a little advice on how to analyze bid-ask spreads.

The upshot of all this: trading commissions, expenses, and bid-ask spreads can all handicap ETF performance.  To reduce ETFs costs, Broker Insider’s advice is:

  • Buy a lot of ETFs at once. You only pay per trade, regardless of the number of ETFs you buy. Monthly “dollar-cost averaging” will only increase your commissions expenses.
  • Buy ETFs with low expenses. Index funds are best. Higher expenses often don’t get you a better portfolio.
  • Buy ETFs with high liquidity. Avoid large bid-ask spreads, which indicate an ETF with low popularity.

By following these strategies, you can invest in ETFs and keep your expenses just a little bit lower than the cheapest mutual funds.

Mutual funds vs ETFs: Which are cheaper? (Part 1)

ETFs are often promoted as a cheaper way to invest than mutual funds. But are the lowest-cost ETFs really any better than the cheapest mutual funds? Broker Insider takes a look.

First, let’s define our terms. An exchange traded fund (or ETF) is basically a special type of mutual fund that you can buy or sell at any time during market hours. This is in contrast to the usual mutual funds, which you can only buy or sell at the end of the day. This “tradability” is advantageous if you like to wait for the precise moment to buy or sell, or want to do it frequently. The drawback is that you’ll need to pay a commission whenever you want to trade. (You can minimize these fees by using very low-cost brokers like Zecco.)

Now when we say ETFs are cheaper, we’re generally saying that they have a lower expense ratio than that of mutual funds. The “expense ratio” is how most funds earn their money, and it is defined as the fund’s annual expenses divided by its total assets.

We can use expense ratios to see that ETFs are actually cheaper, on average. The average ETF expense ratio is only about 0.5%, compared to that of the average mutual fund, which is around 1.5%. But that’s not the whole story, since the average mutual fund ratio conceals a lot of diversity.

The mutual fund average includes both actively managed funds — funds where a fund manager hand-picks the stocks or other assets to be included in the fund — as well as index funds, where the portfolio simply replicates the performance of a stock index like the S&P 500.

Actively managed mutual funds are expensive, since they usually have to pay the high salaries of the celebrity fund manager, marketing expenses, and such. Index mutual funds are much cheaper, since you are mostly paying for a computer to replicate the index by trading in the background. (It’s actually a lot more complicated than that, but take our word for it.)

Most ETFs are essentially identical to index mutual funds, since in most cases they are simply tracking an index, and likewise they are being managed by computer. So really, the relevant comparison is ETFs vs. index mutual funds. (There are no actively managed ETFs — at least, not yet.)

When you compare the average index mutual fund to a typical ETF, the cost difference narrows quite a bit. Index mutual funds typically have expense ratios of 0.2 to 0.6%, making them directly competitive with ETFs. And some of the biggest mutual funds, like Vanguard’s Total Stock Market Index Fund (VTSMX) have expense ratios as low as 0.07% when you invest $10,000 or more.

And that’s the important comparison: you need to compare the expense ratio of an individual ETF to that of a similar individual mutual fund, keeping the asset class (stocks, bonds), investing style (index, preferably), and portfolio management style all the same. This makes sense, because you aren’t buying the average fund — you’re buying a particular fund with a certain objective, and you just want to know that it’s the cheapest way to invest in those assets.

When you do the research, you’ll find that ETFs are often just a hair cheaper than the equivalent mutual fund. Let’s take a look at ETFdb’s list of the cheapest mutual funds. What you’ll see is that Vanguard, Schwab, and iShares are all slugging it out to be the cheapest funds for the biggest indexes, like the S&P 500 or total market funds for stocks or bonds.

There’s a simple reason for this: with the rise of ETFs, there’s suddenly a big land grab going on right now in the investing world. Relatively new fund families like iShares are determined to come out on top, as are old line low-cost mutual fund companies like Vanguard, Schwab, and Fidelity. Thus, for marketing and customer acquisition purposes, they are keeping expense ratios really low — for now — and that means just beating out mutual funds that are managed identically.

So it ETFs are cheaper, right? Well, that’s not the whole story. There’s an issue with trading spreads, and we’ll deal with that in Part 2 of this series.

All forex robots are scams

If you do any research on forex trading, you’ll quickly find dozens of software packages that enable you to automate your buying and selling activity. These “forex robots” or “autopilots” promise to identify currency price trends and trade intelligently on them to make you money. Sadly, forex robots are scams: they don’t work, and only make you lose money faster.

Before we show you that forex robots are a scam, let’s use a simple analogy.

Imagine a world in which you have a goose that lays golden eggs — that is, eggs literally made from gold. All you have do is feed the goose and you gradually become rich, with no risk. Sounds great, right?

Now let’s imagine that your goose could have goslings, and that these baby geese will grow up and lay more golden eggs. The question is: would you give those extra geese away? No, you wouldn’t. After a few generations of these geese were out there, gold would be as common as coal, and your golden eggs wouldn’t be worth anything.

It would make much more sense to keep all the geese and their golden eggs for yourself, because soon you’d be richer than Warren Buffett. And if you didn’t have resources to raise all those chicks yourself, investors would readily pony up some cash to help you, as long as they got a reasonable cut. But if you really had geese that laid golden eggs, you would never share them with anybody, ever!

The only reason you would ever sell such a goose is because it never laid golden eggs in the first place. If you could just convince somebody, somewhere, that these chicks will lay golden eggs, then you’d make way more money than sitting on all your non-existent golden eggs. As long as there are new suckers, you’ll continue to do well.

Forex robots are just like these fake geese. The software doesn’t work for their makers, and so they sell it instead. As long as there are plenty of suckers out there, the robot makers will make money — way more than actually trading with a useless, money-destroying robot.

Unfortunately, forex robots just don’t work for retail forex trading. Robots rely on technical analysis, which isn’t a profitable way to trade forex at the retail level, partially due to high bid-ask spreads. Plus the market is too big and too obscure for technical trends to indicate anything. Since foreign exchange rates are efficient, every trade is essentially a 50/50 coin toss, and one you pay $15 or more to play each time. Using a forex robot just means you lose more money, faster, while you sleep!

What if a forex robot did actually work? If a forex robot worked, it would never be for sale. The maker would just keep it for himself, and to scale up he could easily get Wall Street investors to buy him whole server farms running this intelligent software. (I would invest, wouldn’t you?)

Now, I’m sure that you will see a lot of pretty graphs supposedly proving that a particular forex robot you have your eye on has worked in the past. Don’t trust those graphs, or the robot. It’s easy to fake any graph, and it’s also easy to find a strategy that worked in the past and doesn’t work anymore. It’s also just as easy to fake quotes and testimonials. If you’re still on the fence, just ask yourself: why is this person selling a goose that lays golden eggs? Because the eggs aren’t gold. Heck, they’re probably not even eggs.

In summary: Don’t buy any forex robot or “autopilot” software. You WILL lose money, and lose it faster than trading on your own.

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Ditto Trade Brokerage Review

For the first time in several years, a new online stockbroker has emerged with a (somewhat) unusual business model: Ditto Trade. So what makes Ditto Trade special, and is it worth your time?

Ditto Trade provides the usual stock, options, and forex trading services with a twist: it allows you to “mirror” (that is, watch and/or automatically copy) the trades by other, presumably more experienced investors, whom they call Master Traders. Anybody can sign up to be a Master Trader, and these Master Traders can choose to charge their followers a monthly subscription fee. In this way, Ditto Trade’s business model is similar to that of Covestor, which also allows paid portfolio sharing.

The big difference with Covestor is that there is no minimum fee to share your portfolio, and Ditto Trade doesn’t take a cut of the fee, so this system could be easily adopted by, say, a daughter that just wants to follow her father’s trades, or a bunch of friends who want to follow one particularly enthusiastic trader among them. Unfortunately, you can only follow one Master Trader per account, which means that you can’t really share trades among a group easily. (For that, you might try a site with built-in community like Zecco.)

So, is this a good thing? Well, that depends on the quality of the Master Traders, of which there are only 4 at this time. While Ditto Trade’s Master Traders seem like nice guys, the site provides no data at all on their actual, recent trading success. Covestor, in contrast, provides much more data about the current performance of their traders.

Otherwise, there’s not much to distinguish the trading platform. Commissions are low ($4.95 per trade, plus $0.50 per options contract), but you can do better at Zecco, plus get free trades every month. Forex trading is not integrated into stock and options trading, which is typical of brokers that clear transactions with Penson.

Upshot: Ditto Trade could be an interesting platform for an active trader who’d like to build a business around his superior trading acumen, or perhaps a group of family or friends where one member provides the inspiration for the others. However, if you just want to do basic stock and options trading, cheaper discount brokers are easy to find.

If you have personal experiences with Ditto Trade, we’d love to hear about them below. We’ll keep this review updated as we learn more, too.

Is Zecco a scam?

Sign up with Zecco TradingZecco’s never-ending free stock trading promotion has made investors wonder: is it a scam? We take a look

Zecco Trading has been open and giving away free stock trades since 2006, making some people wonder: is there a catch? We checked, and Zecco is most definitely NOT a scam.  (If it were, we at the Broker Insider would be the first to find out and cry foul.) There are 5 good reasons, and you can check them all yourself, like we did:

  1. Real free stock trades. We independently interviewed customers and the brokerage itself, and it’s true: Zecco provides free stock trades every day, and has done so consistently since 2006.  (Getting the 10 free trades each month requires holding $25,000 in assets.)  Zecco has over 100,000 accounts, and we can’t find a single customer who hasn’t received the free trades they were eligible for.
  2. Offices here in the US. I have personally seen the headquarters in downtown San Francisco, as well as their huge customer service and operations team in Pasadena.   It’s very impressive!  There are over 50 reps in the service center, and they are all in the United States, not in India or the Philippines.
  3. FINRA membership. FINRA is the private-sector body that regulates the stock brokerage industry, and they actually impose more stringent regulations than the SEC does.  Basically, being a member of FINRA (as well as of SIPC) means much tighter operational, marketing, and reporting requirements — not the kind of thing you’d do if you were a scam.
  4. Clearing through Penson. Penson is the company that actually does “clearing” for Zecco, which means that Penson makes sure that stocks actually get traded on the backend.  Penson is the #2 clearing firm, servicing many other discount brokers like TradeKing, MB Trading and OptionsHouse.  The inside scoop from Broker Insider is that, while Penson has its issues, particularly on the integration side, their clearing services are very fast and reliable.  Zecco benefits from this with very fast executions, which experienced traders have noticed.
  5. Similar promotions from other brokerages. Both Wells Fargo and Merrill Lynch offer similar quantities of free stock trades to their brokerage customers.  We can really recommend either as brokerage platforms, though, and Zecco has low stock commissions of only $4.50 each once you’ve used up the free trades.

In summary: Zecco Trading is not a scam, but a completely legitimate online stock broker that just happens to offer free trades as a marketing tactic. Sign up for Zecco and get free stock trades today.

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