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There are mainly 2 ways that your stock broker earns money from you and it is important you are aware of it.
Commissions
When you buy or sell any stocks, the broker charges you a commission for the service of facilitating the transaction. Commission generally cost about S$25 per transaction (a buy or a sell) for Singapore brokers. A round trip of both buy and sell will consitute 2 x S$25 = S$50. This will affect your trading as your winning trade results in lesser profits and your losing trade results in larger losses. For example, if you bought a contract worth S$1,000, the percentage of your cost is 2.5% and you pay S$1,025. Before you even see your profit, you are down 2.5%. The contract if goes up to S$1,100, you profit S$75 instead of S$100. If the contract goes to S$900, your loss becomes S$125 instead of S$100. Another point to note is that you should not invest with an amount that is too small such that the commission is quite significant. This is especially so if you are making frequent trades, these costs will add up. If your expected gain is around 5% each time you trade, a 2.5% commission cost will wipe out half of your earnings.
Spread or Slippage
In addition to commission, the broker who is a market maker can earn through slippage (find out more about Market Maker: What is a Market Maker and How do Market Makers make Money?) Slippage is like arbitrage where you buy lower and sell higher while earning the difference. To illustrate, the exchange listed price of XXX company share is S$1.00 but a broker may sell at S$1.05 and buy at S$0.95. The S$1.05 – S$0.95 = S$0.10 becomes the profit for the broker. In other words, you pay S$1.05 per share (or sell S$0.95 per share) when the actual price is S$1.00. The reason for this slippage is to ‘reward’ the risk assumed by the broker being the market maker. We all understand that a transaction will only go through when there is both a buyer and a seller agreeing on a price. However, the market maker may take in buy orders (or sell) without immediately filling the other side of sell orders (or buy). By temporary holding to these orders, they are subjecting themselves to price changes. During high volatility period where prices change rapidly, the spread becomes larger so as to further protect the market maker.
Besides market makers, there are brokers who provide Direct Market Access (DMA), that is, the price transacted as what the exchange reflects. In this way, there will be no spread earned by the DMA brokers. However, the commission charges will be higher.
You can see that the cost of investing can be high especially if you trade regularly. As mentioned above, if you trade frequently, your profits are likely to be small, and you will have to watch out for trading costs, such that they do not erode your earnings in the long run.
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{ 4 comments… read them below or add one }
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Hi, I am very new to this and hope someone could help me with the following:
Can the broker earn our money through the differences in exchange rate? I was quoted a rate for S$ to HKD (0.183) by the broker which was higher than the actual rate (0.1818) stated by the bank during ABC IPO. I only realised that after I did some research on the exchange rate for that day. The amount loss was up to 4 figures in S$. I questioned the broker about it and the explanation given was that this rate of 0.183 was set by ABC IPO to ease the IPO application. The broker was unable to provide evidence to support the claim. The only thing that the broker said was that I had agreed to this rate.
Hope someone could provide answers for the following questions:
1) Am I wrong to assume that all brokers in reputable firms had to follow the company’s rate when quoting the rate to customers?
2) Are they allowed to earn from the differences in exchange rate. Is it an acceptable practice among all brokers?
3) Do I have the right to demand for a refund for the difference?
4) To avoid future incident, other than checking on the actual rate online and not just listening to the broker. What other factors should I consider?
I have not experienced this problem, maybe my trades are small so they were not glaring. But little bits will add up significantly overtime. Thanks for the heads up, I will monitor this in the future!
What I know is that the brokerage adjusts the exchange rate according to the foreign exchange market. They act as money changers.
1) I would assume the same thing too. I believe it is of the company’s interest to standardise and not let it’s staff undercut one another.
2) It is possible the brokerage can earn some money through the process, as they act as money changers.
3) Maybe you should get an explanation from the brokerage
4) For large investment, say $100,000, you can call the broker to negotiate for a better exchange rate, BEFORE you put in the money. Smaller than that, you would lose your bargaining power
Thank you Alvin for your advice.
According to the broker, the brokerage’s rate for 30 June 2010 is
$0.1818 $0.1797
$0.1812 $0.1791
$0.1809 $0.1788
$0.1808 $0.1789
I checked the website and the rate given on the yahoo currency exchange is 0.1797.
But I was quoted 0.183 instead.
Just called my broker to clarify and it seems that they were unable to provide an explanation. The only reason shared was that it is a company’s decision to have that rate of 0.183 for ABC IPO. No supporting doc could be given.