MAKING TRANSACTIONS IN THE SECURITIES MARKETS
by
Charles Lamson
In many respects, dealing in the securities markets almost seems like you are operating in another world---one with all kinds of unusual orders and strange-sounding transactions. Actually making securities transactions is relatively simple once you understand the basics---in fact, you will probably find it is no more difficult than using a checking account! Indeed, while making money in the market is not all that easy, making transactions is.
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Stockbrokers
Stockbrokers, or account executives and financial consultants, as they are also called, purchase and sell securities for their customers. Although deeply ingrained in our language, the term stockbroker is really somewhat of a misnomer, because such an individual assists you in the purchase and sale of not only stocks, but also, bonds, convertibles, mutual funds, options, and many other types of securities. Brokers must be licensed by the exchanges and must abide by the strict ethical guidelines of the exchanges and the SEC. They work for brokerage firms and in essence are there to execute the orders placed. The largest stockbrokerage firm, Merrill Lynch, has brokerage offices in virtually every major U.S. city (and many foreign countries). Orders from these offices are transmitted by brokers to the main office of Merrill Lynch and then to the floor of one of the stock exchanges or the OTC market, where they are executed. Although the procedure for executing orders on organized exchanges differs a bit from that in the OTC market, you as an investor would never know the difference, because you would place your order with the broker in exactly the same fashion.
Selecting a Broker
If you decide to start investing with a so-called full-service broker, it is important to select someone who understands your investment objectives, and who can effectively help you pursue them. If you choose a broker whose own disposition toward investing is similar to yours, you should be able to avoid conflict and establish a solid working relationship. A good place to start the search is to ask friends, relatives, or business associates to recommend a broker. It is not important---and often not even advisable---to know your stockbroker socially because most, if not all, of your transactions/orders will probably be placed by phone. In addition, a strict business relationship eliminates the possibility of social concerns, interfering with the acheivement of your investment objectives. This does not mean, of course, that your broker's sole interest should be commissions. Indeed, a broker should be far more than just a salesperson; a good broker is someone who is more interested in your investments than his or her commissions. Should you find you're dealing with someone who is always trying to get you to trade your stocks, or who is pushing new investments on you, then by all means, dump that broker and find a new one!
Full-Service, Discount, and Online Brokers
Just a few years ago, there were three distinct types of brokers---full service, discount, and online---and each occupied a well-defined market niche. Today, the lines between these three types of brokers are no longer clear cut. Most brokerage firms, even the most traditional ones, now offer online services to compete with the increasingly popular online firms. And many discount brokers now offer services once available only from a full-service broker, like research reports for clients. The traditional full-service broker offers investors a full array of brokerage services, and margin loans. Such services are fine for those investors who want such help---and are willing to pay for them! In contrast, those investors who simply want to execute trades that are not interested in obtaining all those brokerage services should consider either a discount broker or online broker. Discount brokers tend to have low overhead operations and offer fewer customer services than full-service brokers. Those with the very lowest commissions and who offer hardly any of the normal broker services, other then executing trades, are called deep discounters. Many discount brokers, however, do provide research and other services, but charging the broker's Web site---and placing the desired buy or sell order. The brokerage firm then executes the order at the best possible price and confirms the details of the transaction by phone, email, or regular male. Depending on the size of the transaction discount brokers can save investors from 30 to 80 percent of the commissions charged by full-service brokers.
With the technology that is available to almost anyone today, it is not surprising that investors can just as easily trade securities online as on the phone. All you need is an online broker (also called Internet or electronic brokers) and you, too, can execute trades electronically. The investor merely accesses the online broker's Web site to open an account, review the commission schedule, or see a demonstration of the available transactional services and procedures. Confirmation of electronic trades can take as little as 10 seconds and most occur within one minute. Online investing is becoming increasingly popular, particularly among affluent, young investors who enjoy surfing the Web---so much so, in fact, that it has prompted virtually every traditional full-service broker (and many discount brokers) to offer online trading to their clients.
Brokerage Services
While discount or online brokers offer little more than execution of trades, that is certainly not the case with full-service brokers. Indeed, these brokers offer their clients a wide variety of brokerage services. For that reason, selecting a good brokerage firm is often just as important as choosing a good broker, because not all brokerage firms provide the same services. Try to select a broker with whom you can work and who is affiliated with a firm that provides the type of services you are looking for. Many brokerage firms, for example, provide all sorts of information, ranging from stock and bond guides to research reports on specific securities or industries. Some have a research staff that periodically issues analyses of economic, market, industry or company behavior and events, and relates them to its recommendations for buying or selling certain securities. As a brokerage firm client, you can expect to recieve monthly bulletins discussing market activity and possibly even a recommended investment list. You will also receive an account statement describing all your transactions for the period, commission charges, interest charges, dividends and interest received, the securities you currently hold, and your account balances.
Most brokerage offices provide up-to-the-minute stock price quotation and world news. Stock price information can be obtained either from a quotation board (a large screen that electronically displays security transactions within minutes of the occurrence) or from the computerized telequote system. World news, which can significantly effect the stock market, is obtained from a news wire service. Most offices also have a reference library the firm's clients can use. Another valuable service offered by most major brokerage firms is the automatic transfer of surplus cash left in a customer's account into one of the firm's money funds, thereby allowing the customer to earn a return on temporarily idle funds. Brokerage houses will also hold your securities for you, as protection against their loss, the securities kept in this way are said to be held in street name. Some of these services are also offered by discount brokerages.
Investor Protection
As a client, you are protected against the loss of securities or cash held by your broker by the Securities Investor Protection Corporation (SIPC)---a nonprofit corporation authorized by the Securities Investor Protection Act of 1970 to protect customer accounts against the financial failure of a brokerage firm. Although subject to SEC and congressional oversight, the SIPC is not an agency of the U.S. government.
SIPC insurance covers each account for up to $500,000 (of which $100,000 may be in cash balances held by the firm). Note, however, that SIPC insurance does not guarantee that the dollar value of the securities will be recovered. It only insures that the securities themselves will be returned. So what happens if your broker gives you bad advice, and, as a result, you lose a lot of money on an investment? SIPC will not help you, as it is not intended to insure you against bad investment advice. Instead, if you have a dispute with your broker, first discuss the situation with the managing officer at the branch where you do your business. If that does not do any good then write or talk to the firm's compliance officer and contact the securities office in your home state. If you still do not get any satisfaction, you may have to take the case to arbitration, a process whereby you and your broker present the two sides of the argument before an arbitration panel, which then makes a decision about how the case will be resolved. If it is binding arbitartion, and it usually is, you have no choice but to accept the decision---you cannot go to court to appeal your case. Many brokerage firms, in fact, require you to resolve disputes by going to binding arbitration. Thus, before you open an account, check the brokerage agreement to see if it contains a binding arbitration clause.
Odd or Round Lots
Security transactions can be made in either odd or round lots. An odd lot consists of fewer than 100 shares of stock, while a round lot represents a 100-share unit or multiples thereof. The sale of 400 shares of stock would be considered a round-lot transaction, but the purchase of 75 shares would be an odd-lot transaction; trading 250 shares of stock would involve two round lots and an odd lot. Because the purrchase or sale of odd lots requires additional processing and the assistance of a specialist (an odd lot dealer), an added fee---known as an odd-lot differential--- is often tacked on to the normal commission charge, driving up the costs of these small trades. Indeed, the relatively high cost of an odd-lot trade is why it is best to deal in round lot whenever possible.
Brokerage Fees
Brokerage firms receive commissions for executing buy and sell orders for their clients. Brokerage commissions are said to be negotiated, which means that they are not fixed. In practice, however, most firms have established fee schedules that they use with small transactions (on larger, mostly institutional trades negotiation of commissions actually does not take place). Although these fees are not really negotiated they do differ from one brokerage firm to another; thus it pays to shop around. Also, if you are an ""active trader," generating a couple thousand dollars (or more) in annual commissions, then by all means try to negotiate a reduced commission schedule with your broker. Chances are, they will probably cut a deal with you---the fact is, brokers much prefer traders to buy-and-hold investors, because traders generate a lot more commissions. Generally speaking, brokerage fees on a round lot of common stock will amount to approximately 2 to 4 percent of the transaction value.
*SOURCE: PERSONAL FINANCIAL PLANNING, 10TH ED., 2005, LAWRENCE J. GITMAN, MICHAEL D. JOEHNK, PGS. 451-454*
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