Photo Credit: hernan.seoane
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.
{ 1 comment… read it below or add one }
To minimise trading cost…… get yourself an Online Trading Account !!!!!