Online Trading Advantages and Disadvantages
Online trading, or direct access trading (DAT), of financial instruments has became very popular in the last five years or so. Now almost all financial instruments are available to trade online including stocks, bonds, futures, options, ETFs, forex currencies and mutual funds. Online trading differs in many things from traditional trading practices and different strategies are needed for profiting from the market.
In traditional trading, trades are executed through a broker via phone or via any other communicating method. The broker assist the trader in the whole trading process; and collect and use information for making better trading decisions. In return of this service they charge commissions on traders, which is often very high. The whole process is usually very slow, taking hours to execute a single trade. Long-term investors who do lesser number of trades are the main beneficiaries.
In online trading, trades are executed through an online trading platform (trading software) provided by the online broker. The broker, through their platform offers the trader access to market data, news, charts and alerts. Day traders who want real-time market data are provided level 1.5, level 2 or level 3 market access. All trading decisions are made by the trader himself with regard to the market information he has. Often traders can trade more than one product, one market and/or one ECN with his single account and software. All trades are executed in (near) real-time. In return of their services online brokers charge trading commissions (which is often very low – discount commission schedules) and software usage fees.
Advantages of online trading include, fully automated trading process which is broker independent, informed decision making and access to advanced trading tools, traders have direct control over their trading portfolio, ability to trade multiple markets and/or products, real-time market data, faster trade execution which is crucial in day trading and swing trading, discount commission rates, choice of routing orders to different market makers or specialists, low capital requirements, high leverage offered by brokers for trading on margin, easy to open account and easy to manage account, and no geographical limits. Online trading favors active traders, who want to make quick and frequent trades, who demand lesser commission rates and who trade in bulk on leverage.
But online trading is not here for all traders. The disadvantages of online trading include, need to fulfill specific activity and account minimums as demanded by the broker, greater risk if trades are done extensively on margin, monthly software usage fees, chances of trading loss because of mechanical/platform failures and need of active speedy internet connection. Online traders are fully responsible for their trading decisions and there will be often no one to help them in this process. The fees involved in trading vary considerably with broker, market, ECN and type of trading account and software. Some online brokers may also charge inactivity fees on traders.