A brokerage firm may charge about $20 to buy or sell up to 5,000 shares. If you have a $20,000 account and buy 200 shares of a $100 stock, the commission of $20 comes to one-tenth of one percent. When you sell those shares and pay another commission, the cost of brokerage rises to approximately two-tenths of one percent of your equity.
Trade like that once a week, and at the end of the month your broker will have earned one percent of your account, regardless of whether you made money. Keep going like that for a year, and your commission cost will rise to 12% of your equity. That’s a lot of money. Professional money managers are happy with 25% annual returns, year after year. They could not generate them if they had to pay 12% annually in commissions. But wait, it gets worse.
Look at a small trader who can afford only 100 shares of a $20 stock. His purchase price is $2,000, but he pays the same $20 commission, which eats up a whopping 1 percent of his equity. When he closes that trade and pays another commission, he is 2 percent behind the game. If he trades like that once a week, by the end of the month his commissions will come to 10% of his account, more than 100% on annualized basis. The great George Soros averages 29% annual gain. He could have never accomplished that if he had to jump over a 100% commission barrier.
The bigger your account, the smaller the percentage eaten by commissions and the lower your barrier to winning. Having a large account is a great advantage, but whatever your size, do not be hyperactive. Each trade and each seemingly cheap commission raise the barrier to your success. Design a system that doesn’t trade very often.
I’ve met futures traders who paid $80 roundtrip commissions to fullservice brokers. That was the price of allegedly sage advice, but any disinterested professional will tell you that a futures trader who pays $80 roundtrip has no chance of winning. Why do people pay such exorbitant rates? Because the little lamb who ventures into a dark forest is so afraid of the big bad wolf, the professional trader, that he hires himself a protector to guide him, a full-service broker. Once you do the math, it becomes clear that you’re better off taking your chances on the wolf than signing up for a guaranteed skinning by your protector.
There are full-service brokers whose advice is worth the money. They bring good tips, get good fills, and their commissions are not exorbitant. The catch is that they only accept very large accounts that generate a high volume of business. Bring them a million-dollar account with a history of active trading, and you may get their attention.
If you have an account in five or six figures and trade only a couple of times a week, do not waste your time and money looking for false security of an expensive broker. Get a cheap, reliable, no-frills broker that you can easily reach via the Internet or on the phone—and start looking for good trades.
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