Hey Rookie Bloggers! This will be the last in this series of blog posts about brokers. I feel like we covered this very well with one small exception? I forgot to explain why it truly matters about commission rates and why it is so important to get the best deal for you that still fits within your own trading style.

I am not sure how many of you that are reading this blog have actually thought about what you pay in commissions or how it affects your bottom line and moreover I am not sure how many of you have actually run the numbers to see the difference that a fair commission structure can make. In last week’s blog, I spoke mostly about getting filled and the order types that are available and the pitfalls that may be present. This was an important conversation to have but I feel like I forgot the other side of this debate and that is what is the true cost of getting good fills and/or decent service from your broker. I am hoping that the following story will shed some light on this topic.

Have you ever gone to a store and looked at an item you really wanted and then looked at the price tag and thought, WOW that is very expensive! I bet you all have and I would also bet that the vast majority have thought I could totally get that cheaper somewhere else? Well, today with the internet at our very fingertips we have quick access to all the prices we could ever want and we can then make an informed decision when it comes to our buying decisions, however, what if the item you want is pretty much the same price everywhere but there are “similar” products in the market place for much cheaper, does this affect your buying decision? Most people would answer yes to that question, myself included. Now, typically the cheaper alternative may work out just as well as the more expensive option, let’s say you are shopping for a new TV set, I would say that although there are subtle differences between brands that most folks could deal or may not even notice the difference in quality? I am sure some will argue with me on this point but in my experience, this is pretty much the case. Now, let’s take a different example, maybe you are one of those back yard mechanic DIYer type folks that like to tinker around with your car or maybe projects at the house and let’s say you need to buy a tool to get the job done? We are going to use an ordinary wrench for this example. Let’s say you need a wrench to get the lugs off your tire and you goto one of the discount stores and buy a no-name wrench and you start to put a little torque on the nut to loosen it off and low and behold the wrench either slip off or snaps all together! The low price of that wrench at that point doesn’t seem like such a bargain anymore, perhaps if we had forked out a couple of extra dollars for a brand name wrench with a good reputation then perhaps we might still have the skin left on our knuckles. I only tell you this story because I have lived this very event and it taught me a lesson, sometimes you do get what you pay for!

Now, how does this relate to trading? Well, I went over the scenario last week in which an order type that I used cost me over half of what I should have gotten for selling the option I bought! So, should I have remembered that you get what you pay for? The answer to that, is perhaps? Perhaps because although it would have gotten me a decent fill at another broker who charges more commission would it have been worth the cost? This is where we need to do a little math and we need to talk about one of the most important concepts that a trader faces. That is concept is TRADING EDGE! You must have an edge in trading if you are going to beat the pseudo-zero-sum game that is trading. I say pseudo because when you factor in commissions and fees trading really isn’t a zero-sum game, its worse than that. For those not familiar with the zero-sum concept, it is essentially a game in which there are a winner and a loser in each transaction. In trading, this is simple if you buy a stock and it goes up and you sell it for a profit then whoever was on the other side of that trade had to lose that same amount. Here’s where trading gets harder, there is a winner, loser and there are fees. Commission and fees are paid regardless of who wins or loses and therefore over time all the capital in that game would be eaten up in this manner and that is why you need a trading edge, you need to be not only able to win on the trades but you also need to be able to overcome the fees and at the end that is your profit or loss.

So let’s look at how this affects traders using the example of IB versus another very popular broker TOS. Now, I am using the example of what Canadian trader pay in commission as it is very different for our American friends as I alluded to in the blog last week.

So here goes, I am going to use the example of doing 10 AAPL bull put spreads in each broker and then we will break down the costs into percentages of the profit possible and see what edge we have to overcome in each scenario. The prices I state are what I see right now and may or may not be different for other traders, just FYI.

To buy 10 AAPL bull put spreads in IB will cost $6.03 USD for the ability to make $1.90 per share or $1900 for the entire trade. If we take the $6.03 and divide it by the potential profit of the trade then it comes out to approximately 0.31% of the potential profit in the trade. This is an edge we can overcome through good trading principles such as good money management, good technical and fundamental analysis, etc.

To buy 10 AAPL bull put spreads in TOS will cost $25 USD for the ability to make $1.90 per share or $1900 for the entire trade. If we take the $25 and divide it by the potential profit of the trade then it comes out to approximately 1.31% of the potential profit of the trade. You can see that we need to do much better to overcome this commission and fee structure.

So you can why I said perhaps when we referred to the get what you pay for adage when it comes to trading? You see this is a big dilemma for traders who are stuck with high commissions and this does not just include Canadian traders as I have heard from other students living in places other than the US that suffer the same fate. So the question becomes what can we do about it?

Well, as I said last week I use multiple brokers for many different reasons and some of those reasons can be what type of trading one is doing. For example, if a trade is buying stocks and selling covered calls and doing this repeatedly then a discount brokerage like IB can work well for this type of trading as the order types can work in entering and exiting the trades, however when a trader starts getting into trades that require exiting option trades at specific prices or in specific ways then maybe a full-service broker is the way to go. The only way you will know which is the right way to go is to give it some thought about how you trade and I would even go as so far as to make this a section in your trading business plan as it absolutely affects your bottom line.

I have one final thought for anyone who is stuck in a high commission or fee environment, I would implore you to find out why that is so I would also suggest that you do everything in your power to affect change. If you are not getting decent commission rates or service because of government red tape then I would suggest contacting your local politician and demanding that something is done about it and I will also suggest that you gather like-minded individuals and express your dissatisfaction as there is always strength in numbers. We had a saying in this blog that you get what you pay for and here is another, the squeaky wheel gets the grease.

So, hopefully, you can see how commission structures affect your bottom line and you have the wherewithal to figure out what is best for your trading business and are willing to figure out a plan that puts you in the best position to be successful.

Happy Trading All,

Coach Holmes.