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Why Challenger Brokerages Should Embrace Radical Transparency

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Why Challenger Brokerages Should Embrace Radical Transparency

Alan Grujic, Founder and CEO, All of Us Financial

At the start of October, Charles Schwab, a broker with a nearly 50-year history, announced it was introducing fee-free trading. This legacy player was almost certainly responding to seismic market changes brought about by challenger brokers, most notably Robinhood, who have long offered fee-free trading.

If transaction fees were the golden egg sustaining the brokerage industry, Robinhood was the farmer who broke it. Canny observers will note that it was only a matter of time until the rest of the industry followed suit, with legacy players either reducing or eliminating the fees they charged per trade. It is, after all, hard to compete with free.

This leads to critically important questions: If the entire industry pivots to fee-free trading, how will brokerages make money? And, crucially, can brokerages make money without undermining the interests of their customers, many of whom have embraced the stock market for the first time in their lives?

From Mobiles to Markets

On its surface, no-fee trading sounds exciting, but the truth is these fees never needed to be charged in the first place.

Think of telco operators back in the 90s, who all tripped over themselves to offer free long-distance calling when in reality it didn’t cost more money to place a long-distance call than a local call. Technical advancements made it impossible to charge long-distance, and once the first operator sought out a competitive advantage, they all followed. In a similar way, the time for extraneous fees in investing has ended. However, the real financial boon to brokerage firms isn’t just in trading fees, it’s in the amount of money they earn on each individual customer, figures they’ve never been willing to share.

For much of their history, brokerages charged investors crushingly-high fees. Each buys or sell order came with a commission attached, which could cost $10 or more. In addition, small “mom and pop” investors often paid annual maintenance fees, either as a percentage of their portfolio or as a flat sum. Collectively, these charges disproportionately diluted any potential profits, thereby deterring many low-net-worth individuals from investing in the stock market.

And like long-distance calling, these fees were wholly unnecessary. Few knew that the cost to place a trade was negligible compared to the sum levied by the brokerages. And it wasn’t long until a new generation of startups figured this out and launched their own commission-free trading platforms.

This happened in 2013, with the launch of Robinhood. This platform, which boasts 6 million users, is today worth an estimated $7.6 billion. That figure will inevitably grow as the company expands. It’s currently in the early stages of European expansion, with a UK launch expected later this year. Across the Atlantic, Freetrade offers a similar service. In April this year, the app-based broker raised £1 million (roughly $1.2 million) in 77 seconds via Crowdcube, a popular equity crowdfunding platform.

The enthusiasm for these platforms highlights two unassailable truths. Firstly, there’s a large appetite among retail investors for services that cheaply facilitate stock trading. Secondly, and even more to the point, many of the fees charged by legacy brokers were simply unjustifiable. Collectively, challenger brokerages’ entry into the market has had a disruptive effect, forcing legacy players to lower their commissions drastically or cull them altogether.

A Brave New Market

So, how will brokers make money when they can no longer charge on a per-trade basis?

There are a few answers to that. The most obvious is that many challenger brokers act like ultra-low-cost airlines, where they make money from ancillary services rather than the core product itself.   This “freemium” model is extremely popular. Freetrade, for example, batches trades together and executes them at 4PM daily. If you want your order to go through immediately to capitalize on a particular price in the market, you’ll need to pay roughly $1.25.

Likewise, Robinhood offers commission-free trading but charges a fee for trades made on margin. Users with a minimum balance of $2,000 can borrow twice their capital to trade with. They’re charged a flat fee depending on the amount they borrow.

Other revenue streams, however, are perhaps less savory. In October 2018, it emerged that half of Robinhood’s revenue came from third parties wishing to influence the way it executes orders. This controversial practice is called “payment for order flow,” or PFOF, and was pioneered by the disgraced financier Bernie Madoff.

Critics of PFOF argue that it incentivizes brokerages to execute orders with whatever market maker will make them the most money, rather than what is in the best interest of the client. Although it’s illegal in many jurisdictions (the UK banned it in 2012), it remains an accepted practice within the US financial services sector.

Of course, there are always two sides to every story. Proponents of PFOF say it’s an essential component for monetizing fee-free trading. They state that without it, platforms like Robinhood simply wouldn’t exist. Payment for order flow, it’s argued, is the mechanism that stops us from reverting to the dark era of $10 commissions on trades.

Yet another way brokerages are making money is by lending out hard to borrow stocks to those who have sold shares they don’t own, a practice called short selling. Short-sellers borrow stock they have sold so that they can deliver it to the buyer, thereby betting its price will fall. When they buy back their shares at a lower price than they sold them, they are able to return their borrowed shares to their lender, and profit from the price difference. –Brokerages lend out customer shares but don’t share the money they make doing this with their customers, who own those holdings in the first place.

Transparency is Key

For what it’s worth, the SEC mandates that platforms using PFOF inform their customers on a quarterly and annual basis, after a trade is executed, and via their terms of service (which, let’s be honest, few people bother to read anyway). But is that enough? No, it’s not.

Brokerages need to provide the most honest, fair and transparent information available for investors today, ensuring that people know how their money is being put to use. As it stands, this industry is sorely lacking a purpose-driven brand that genuinely puts its customer’s interests over their own. When you peel back the curtain it reveals that investment firms and platforms make excessive amounts of money on their customers – money that each investor could be earning more of on their own. The truth is that free trading isn’t really free. The individual investor might not be explicitly asked to pay fees, but trust me when I say the brokerage firms are still making money off each and every trade, and making it seem like they are not is intentionally misleading to the consumer.

With an industry notorious for its bad actors, radical transparency can allow challenger brokerages to develop their brand, and crucially, instill trust with their customers. It will allow investors to see whether their brokers truly have their best interests at heart, or whether they would be better served to move their portfolio elsewhere.

Consumers today have a different value system for companies they engage with, and that extends to investments as well. New generations are digital and social-media natives, expecting to tap into the benefits of both in everything they do. Consumers also place a much higher premium on trust and transparency with brands and never is this more evident than with those to whom they entrust their money.

It was Benjamin Franklin who once famously said: “An investment in knowledge pays the best interest.” Complete transparency is possible and should be required and embraced by investors.

Trading

How has the online trading landscape changed in 2020?

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How has the online trading landscape changed in 2020? 1

By Dáire Ferguson, CEO, AvaTrade 

This year has been all about change following the outbreak of coronavirus and the subsequent global economic downturn which has impacted nearly every aspect of personal and business life. The online trading world has been no exception to this change as volatility in the financial markets has soared.

Although the global markets have been on a rollercoaster for some time with various geopolitical tensions, the market swings that we have witnessed since March have undoubtedly been unlike anything seen before. While these are indeed challenging times, for the online trading community, the increased volatility has proven tempting for those looking to profit handsomely.

However, with the opportunity to make greater profits also comes the possibility to make a loss, so how has 2020 changed the online trading landscape and how can retail investors stay safe?

Lockdown boost

Interest rates offered by banks and other traditional forms of consumer investments have been uninspiring for some time, but with the current economic frailty, the Bank of England cut interest rates to an all-time low. This has left many people in search of more exciting and rewarding ways to grow their savings which is indeed something online trading can provide.

When the pandemic hit earlier this year, it was widely reported that user numbers for online trading rocketed due to disappointing savings rates but also because the enforced lockdown gave more people the time to learn a new skill and educate themselves on online trading.

Dáire Ferguson

Dáire Ferguson

A volatile market certainly offers great scope for profit and new sources of revenue for those that are savvy enough to put their convictions to the test. However, where people stand the chance to profit greatly from market volatility, there is also the possibility to make a loss, particularly for those that are new to online trading or who are still developing their understanding of the market.

The sharp rise in online trading over lockdown paired with this year’s unpredictable global economy has led to some financial losses, but with a number of risk management tools now available this does not necessarily have to be the case.

Protect your assets

Although not yet widely available across the retail market, risk management tools are slowly becoming more prevalent and being offered by online traders as an extra layer of security for those seeking to trade in riskier climates.

There are a range of options available for traders, but amongst the common tools are “take profit” orders in conjunction with “stop loss” orders. A take profit order is a type of limit order that specifies the exact price for traders to close out an open position for a profit, and if the price of the security does not reach the limit price, the take profit order will not be fulfilled. A stop loss order can limit the trader’s loss on a security position by buying or selling a stock when it reaches a certain price.

Take profit and stop loss orders are good for mitigating risk, but for those that are new to the game or who would prefer extra support, there are even some risk management tools, such as AvaProtect, that provide total protection against loss for a defined period. This means that if the market moves in the wrong direction than originally anticipated, traders can recoup their losses, minus the cost of taking out the protection.

Not a day has gone by this year without the news prompting a change in the financial markets. Until a cure for the coronavirus is discovered, we are unlikely to return to ‘normal’ and the global markets will continue to remain highly volatile. In addition, later this year we will witness one of the most critical US presidential elections in history and the UK’s transition period for Brexit will come to an end. The outcome of these events may well trigger further volatility.

Of course, this may also encourage more people to dip their toes into online trading for a chance to profit. As more people take an interest and sign up to online trading platforms, providers will certainly look to increase or improve the risk management tools on offer to try and keep new users on board, and this could spell a new era for the online trading world.

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Trading Strategies

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Trading Strategies 2

By Paddy Osborn, Academic Dean, London Academy of Trading

Whether you’re negotiating a business deal, playing a sport or trading financial markets, it’s vital that you have a plan. Top golfers will have a strategy to get around the course in the fewest number of shots possible, and without this plan, their score will undoubtedly be worse. It’s the same with trading. You can’t just open a trading account and trade off hunches and hopes. You need to create a structured and robust plan of attack. This will not only improve your profitability, but will also significantly reduce your stress levels during the decision-making process.

In my opinion, there are four stages to any trading strategy.

S – Set-up

T – Trigger

E – Execution

M – Management

Good trading performance STEMs from a structured trading process, so you should have one or more specific rules for each stage of this process.

Before executing any trades, you need to decide on your criteria for making your trading decisions. Should you base your trades off fundamental analysis, or maybe political news or macroeconomic data? If so, then you need to understand these subjects and how markets react to specific news events.

Alternatively, of course, there’s technical analysis, whereby you base your decisions off charts and previous price action, but again, you need a set of specific rules to enable you to trade with a consistent strategy. Many traders combine both fundamental and technical analysis to initiate their positions, which, I believe, has merit.

Set-up

What needs to happen for you to say “Ah, this looks interesting! Here’s a potential trade.”? It may be a news event, a major macro data announcement (such as interest rates, employment data or inflation), or a chart level breakout. The key ingredient throughout is to fix specific and measurable rules (not rough guidelines that can be over-ridden on a whim with an emotional decision). For me, I may take a view on the potential direction of an asset (i.e. whether to be long or short) through fundamental analysis, but the actual execution of the trade is always technical, based off a very specific set of rules.

To take a simple example, let’s assume an asset has been trending higher, but has stopped at a certain price, let’s say 150. The chart is telling us that, although buyers are in long-term control, sellers are dominant at 150, willing to sell each time the price touches this level. However, the uptrend may still be in place, since each time the price pulls back from the 150 level, the selling is weaker and the price makes a higher short-term low. This clearly suggests that upward pressure remains, and there’s potential to profit from the uptrend if the price breaks higher.

Trigger

Once you’ve found a potential new trade set-up, the next step is to decide when to pull the trigger on the trade. However, there are two steps to this process… finger on trigger, then pull the trigger to execute.

Paddy Osborn

Paddy Osborn

Continuing the example above, the trigger would be to buy if the price breaks above the resistance level at 150. This would indicate that the sellers at 150 have been exhausted, and the buyers have re-established control of the uptrend.  Also, it is often the case that after pause in a trend such as this, the pent-up buying returns and the price surges higher. So the trigger for this trade is a breakout above 150.

Execution

We have a finger on the trigger, but now we need to decide when to squeeze it. What if the price touches 150.10 for 10 seconds only? Has our resistance level broken sufficiently to execute the trade? I’d say not, so you need to set rules to define exactly how far the price needs to break above 150 – or for how long it needs to stay above 150 – for you to execute the trade. You’re basically looking for sufficient evidence that the uptrend is continuing. Of course, the higher the price goes (or the longer it stays above 150), the more confident you can be that the breakout is valid, but the higher price you will need to pay. There’s no perfect solution to this decision, and it depends on many things, such as the amount of other supporting evidence that you have, your levels of aggression, and so on. The critical point here is to fix a set of specific rules and stick to those rules every time.

Management

Good trade management can save a bad trade, while poor trade management can turn an excellent trade entry into a loser. I could talk for days about in-trade management, since there are many different methods you can use, but the essential ingredient for every trade is a stop loss. This is an order to exit your position for a loss if the market doesn’t perform as expected. By setting a stop loss, you can fix your maximum risk on a trade, which is essential to preserving your capital and managing your overall risk limits. Some traders set their stop loss and target levels and let the trade run to its conclusion, while others manage their trades more actively, trailing stop losses, taking interim profits, or even adding to winning positions. No matter how you decide to manage each trade, it must be the same every time, following a structured and robust process.

Review

The final step in the process is to review every trade to see if you can learn anything, particularly from your losing trades. Are you sticking to your trading rules? Could you have done better? Should you have done the trade in the first place? Only by doing these reviews will you discover any patterns of errors in your trading, and hence be able to put them right. In this way, it’s possible to monitor the success of your strategy. If your trades are random and emotional, with lots of manual intervention, then there’s no fixed process for you to review. You also need to be honest with yourself, and face up to your bad decisions in order to learn from them.

In this way, using a structured and robust trading strategy, you’ll be able to develop your trading skills – and your profits – without the stress of a more random approach.

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Economic recovery likely to prove a ‘stuttering’ affair

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Economic recovery likely to prove a ‘stuttering’ affair 3

By Rupert Thompson, Chief Investment Officer at Kingswood

Equity markets continued their upward trend last week, with global equities gaining 1.2% in local currency terms. Beneath the surface, however, the recovery has been a choppy affair of late. China and the technology sector, the big outperformers year-to-date, retreated last week whereas the UK and Europe, the laggards so far this year, led the gains.

As for US equities, they have re-tested, but so far failed to break above, their post-Covid high in early June and their end-2019 level. The recent choppiness of markets is not that surprising given they are being buffeted by a whole series of conflicting forces.

Developments regarding Covid-19 as ever remain absolutely critical and it is a mixture of bad and good news at the moment. There have been reports of encouraging early trial results for a new treatment and potential vaccine but infection rates continue to climb in the US. Reopening has now been halted or reversed in states accounting for 80% of the population.

We are a long way away from a complete lockdown being re-imposed and these moves are not expected to throw the economy back into reverse. But they do emphasise that the economic recovery, not only in the US but also elsewhere, is likely to prove a ‘stuttering’ affair.

Indeed, the May GDP numbers in the UK undid some of the optimism which had been building recently. Rather than bouncing 5% m/m in May as had been expected, GDP rose a more meagre 1.8% and remains a massive 24.5% below its pre-Covid level in February.

Even in China, where the recovery is now well underway, there is room for some caution. GDP rose a larger than expected 11.5% q/q in the second quarter and regained all of its decline the previous quarter. However, the bounce back is being led by manufacturing and public sector investment, and the recovery in retail sales is proving much more hesitant.

China is not just a focus of attention at the moment because its economy is leading the global upturn but because of the increasing tensions with Hong Kong, the US and UK. UK telecoms companies have now been banned from using Huawei’s 5G equipment in the future and the US is talking of imposing restrictions on Tik Tok, the Chinese social media platform. While this escalation is not as yet a major problem, it is a potential source of market volatility and another, albeit as yet relatively small, unwelcome drag on the global economy.

Government support will be critical over coming months and longer if the global recovery is to be sustained. This week will be crucial in this respect for Europe and the US. The EU, at the time of writing, is still engaged in a marathon four-day summit, trying to reach an agreement on an economic recovery fund.  As is almost always the case, a messy compromise will probably end up being hammered out.

An agreement will be positive but the difficulty in reaching it does highlight the underlying tensions in the EU which have far from gone away with the departure of the UK. Meanwhile in the US, the Democrats and Republicans will this week be engaged in their own battle over extending the government support schemes which would otherwise come to an end this month.

Most of these tensions and uncertainties are not going away any time soon. Markets face a choppy period over the summer and autumn with equities remaining at risk of a correction.

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