Online trading continues to grow in popularity. More than 14 million households in the U.S. are signed up with an online trading service, according to data from Statista, a statistics company. Online trading offers access to almost any stock, bond or other type of security. Its a viable alternative to traditional brick-and-mortar brokerage firms.
With online trading, or e-trading, the trader makes all decisions himself. Such an approach to trading differs from using a stockbroker, as the broker typically offers input and advice. Another difference is in the fees: Online trading is generally considerably less expensive than using a stockbroker to make trades.
Regardless of how you trade, theres always risk online and off. The following list outlines the advantages and disadvantages of online trading.
5 BENEFITS OF ONLINE TRADING
One of the clearest advantages of online trading is the reduction in transaction costs and high fees associated with traditional brick-and-mortar brokerage firms. Typically, youll pay between $5 and $10 to buy and sell stocks and exchange-traded funds at online discount brokerages, according to a Bloomberg report.
Finding even cheaper fees is possible thanks to startups such as Motif and TradeKing, both of which charge $4.95 per ETF or stock trade.
MORE CONTROL AND FLEXIBILITY
Time is often of the essence when you trade stocks, so the speed of using online trading portals is a benefit to many investors. With online trading, you can execute a trade almost immediately.
Traditional brick-and-mortar brokers might require appointments, either online, over the phone or in person, just to initiate a trade. The time involved in such transactions is an inconvenience in the best of circumstances and can actually cost you money in the worst scenarios.
ABILITY TO AVOID BROKERAGE BIAS
By taking trading into your own hands, you can eliminate brokerage bias. Bias sometimes occurs when a broker gives financial advice that benefits the broker such as in the form of a commission for selling specific mutual funds and other products. This kind of biased advice can be troublesome for any investor and might even lead to investment decisions that are good for the broker but bad for you. You can avoid ethically questionable, biased broker advice by using online trading, which lets you invest without having to get advice from a broker.
ACCESS TO ONLINE TOOLS
In the world of online trading, a lower cost does not necessarily mean a shoddy product. Many of todays online trading companies offer customers an impressive suite of tools to help optimize trades.
For example, sites such as TradeKing, Interactive Brokers and Motif offer a robust selection of tools designed to give customers immediate access to valuable information, including interactive investment performance charts.
OPTION TO MONITOR INVESTMENTS IN REAL TIME
Many online trading sites offer stock quotes and trade information that make it easy for people to see how their investments are doing in real time.
Companies such as Scottrade and TradeKing, for example, offer customers access to streaming data. You get real-time quotes, stock market news and more. For some traders, this one-stop, at-a-glance convenience trumps picking up the phone and calling a live broker, turning on the television, or even going to a different website to get market information.
5 DISADVANTAGES OF ONLINE TRADING
EASIER TO INVEST TOO MUCH TOO FAST
Because online trading is so easy you basically push a button there is the risk of making poor investment choices or overinvesting.
The Securities and Exchange Commission warns investors that although it takes just a nanosecond to make a trade, real investment decisions require time. Investors who are not used to fast-moving markets can get caught up in the excitement. Before they know what hit them, they can end up losing a lot of money.
Online investors can protect themselves by understanding the stocks they are buying and setting up safeguards in fast-paced markets. Placing a limit order on your account is one way to control what you buy and how much of it. Order limits allow you to set a specific price at which a stock will purchased.
NO PERSONAL RELATIONSHIPS WITH BROKERS
By and large, online traders are on their own. They dont have a broker to help them navigate the uncertain waters of the stock market.
From getting help on how to create an investment strategy to understanding how the results of feedback mechanisms affect the market, online traders are left to their own devices. For some, this kind of autonomy can be unsettling.
Experts often stress the importance of research, particularly for new traders. You need to learn as much as you can about the companies in which you invest.
SEC filings are a great place to start. Public companies are required to submit detailed information to the SEC on a regular basis, including details about company finances, potential conflicts and risk factors. The public can access this information online.
Trading stocks can be like gambling for some people. The trader speculates on the result of something such as a companys performance and then bets money that the speculation will be correct. Online traders can experience a certain high when trading that is similar to what people experience when gambling, according to a recent study on excessive trading published in the journal Addictive Behaviors.
The study noted that some investors choose short-term trading strategies that involve investing in risky stocks offering the potential for large gains but also significant losses. The structure itself of the two activities (gambling and trading) is very close, the study concluded.
The nature of online trading means that, ultimately, youre at the mercy of your internet connection. If the internet connection is too slow or is interrupted, you can lose out on a potentially important or lucrative trade.
The SEC recommends investors have a backup plan in case they are cut off from the internet. Find out if your online trading firm has alternatives to making trades on the internet. Many firms allow customers to use a touch-tone phone ordering system, and others even provide live brokers to take orders.
BUYING ERRORS DUE TO COMPUTER MISSTEPS
With online trading, to simply assume a trade was not completed can cost you money. Investors who believe their trade was not completed might make the trade again and end up investing twice as much as they intended.
Check with your broker about how to verify canceled trades. The SEC warns that simply receiving an electronic cancellation receipt is not necessarily sufficient evidence that the trade was actually canceled.
Assuming a trade was completed without seeing confirmation of the fact also is a mistake. Make sure you understand how to verify trades and review statements before you begin using an online investing system.