What Is Online Trading and How Does It Work?

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Updated on Thursday, February 14, 2019

You go online to connect with friends, shop for groceries and stream entertainment. But would you consider online stock trading for investments? Many people who trade stocks do so exclusively online, with many brokers offering platforms that make trades seamless from your mobile device as well.

But what is online trading, what are the alternatives and what sort of online brokerage is right for you? Here is some important information you should know about before investing online.

What is online trading?

In the past, one had to have a stockbroker to invest. This stockbroker would take orders over the phone (or in person) and trade on the floor of an exchange in real time. A stockbroker would likely get to know their investor clients, advising them on potential financial moves.

Because an investor needed to have a relationship with a broker to make a trade, this generally meant that investing was primarily for the well-off. After all, a stockbroker or brokerage firm only has so much bandwidth to personally handle clients, meaning that investment minimums were often quite high. To sell a stock, a stockbroker had to be on the trading floor, yelling orders and using hand gestures to negotiate buys and sells.

As technology evolved, electronic communication networks gained prominence in the ‘90s, making it possible for computers to match buy and sell orders on the market automatically. Coupled with sophisticated algorithmic programs, stocks were easier to buy, sell and trade. As online trading grew, minimum investment requirements fell and brokerage firms that specialized in online trading became more popular.

Today, traditional brokerages and stockbrokers still exist — and the trading floor of the New York Stock Exchange remains active and loud — but even serious investors with millions of dollars in the market may choose to trade online exclusively.

The advantages of investing online

With many discount brokers, online-only brokers and robo-advisors, online investing can be simple, even for a beginner. Online trades typically have far lower fees than the commissions that might go to a broker on the floor.

Online investing can also happen on your own time, and online investing may make you feel like you have more control in terms of deciding when and what you want to trade. Online investing platforms often have robust education resources, allowing investors the opportunity to learn about the markets on their own time.

The disadvantages of investing online

For beginning investors, the lack of human touch may make it possible to invest too much or to make inadvisable snap decisions based on market volatility. Some brokerages offer access to human brokers for what are called broker-assisted trades, although the fees are usually much higher than purely electronic trades.

Floor traders may still have some slight advantages in making market volatility work in their favor. For example, floor traders have access to the d-Quote, a tool which can be used up until the stock market closes at 4:00 p.m. Eastern time (which can be some of the most valuable minutes of the day). Stockbrokers on the floor can also step in during times of electronic error, and fans of in-person trading say that the human touch can be especially important during times of financial crisis.

In general, though, online trading can be a smart and economical decision for beginning and experienced investors alike. Of course, it’s important to remember that whether you’re having investments traded with the assistance of a broker or traded electronically, all investment carries risk.

How do you begin trading online?

To trade online, you need to choose a brokerage and open an account. How do you choose a brokerage? That depends on a host of factors including fees, account minimums and even how well you like the interface of the brokerage’s online platform.

Getting started

After you’ve set up a brokerage account, you may want to decide which stocks to purchase. It can be tempting to pick stocks based on recent news headlines, a hot tip you saw in your Facebook feed or even companies you like and believe in. But for every “I bought Apple stock in 1987” success story, there are investors who have lost major money on hunches and headlines. Do your due diligence, look at market performance, and also decide why you may want to trade online.

Trading online can be fun, exciting and a good way to make money, but it can also be risky if you have limited knowledge or experience. Of course, one of the ways you can gain valuable experience is by jumping in, but it may make sense to invest a small amount of money when getting started and add more over time as you become familiar with your risk tolerance.

If your goal is to have a dynamic portfolio but you don’t necessarily have the time to manage it yourself, looking into brokerages that offer robo-advisor services may make the most sense. A robo-advisor is an algorithm that can manage your portfolio based on factors including your risk tolerance and financial goals for the account.

Finally, it may make sense to work with a financial advisor to help you clarify your financial goals. Some brokerages can offer clients a referral to an independent financial advisor who may be able to suggest the best path for you.

Making trades

When you’re ready to trade, you need to decide whether you’re going to execute a market order or a limit order. A market order is a buy or sell order that happens immediately at market prices. A limit order will cap the maximum or minimum price the stock should be at to buy or sell.

Once your order is executed, make sure the order went through — some tech glitches might make it difficult to ascertain whether or not an order was processed, and an erroneous double-click or backspace can be a costly mistake. Finally, know how your trades are being paid for. For example, if you purchase a security in a cash account, it must be paid for before it is sold or traded.

As you begin to buy, sell and trade, you’ll learn more about how trades work, pitfalls to avoid, and hopefully have some of your own “Apple stock in 1987” stories. But it’s also equally important to remember all the other avenues for investing, including mutual funds, money market funds and IRA accounts. While these may not be as “exciting” as the rise and fall of the stock market (although they all still carry risk), these avenues can be a way to invest without necessarily exposing yourself to the same types of risk that the stock market may bring.

How much does it cost to trade online?

Online trading may be much less expensive than opening an account at a full-service brokerage firm, but fees and commissions can add up. That’s why it’s important to compare fees across brokerages.

An online brokerage account will likely come with investment fees. While fees vary for a variety of services, they can add up over time. Fees that beginning investors are likely to come across include:

  • Platform fees: Platform fees are the administrative costs of having an open investment account and may include inactivity fees or transfer fees if you wish to close the account or transfer funds. For example, Vanguard has an annual $20 platform fee for brokerage accounts, which can be waived if an investor chooses to enroll in their e-delivery service instead of receiving paper statements.
  • Trading fees: This is the commission cost for each stock trade. For example, TD Ameritrade has a $6.95 fee per online equity trade.
  • Advisory fees: If you’re having your account managed by a robo-advisor, you may be charged an advisory fee that is a certain percentage of your total account balance. For example, Ally Invest has a 0.30% advisory fee for automated investment portfolios.

As more online trading platforms have burst onto the scene, fierce competition for clients has meant fierce fee competition between brokers. Are there any online brokers who offer free or cheap trades? Yes. For example, Robinhood is an online-only platform that offers commission-free trades.

So why wouldn’t one want to simply go with the brokerage that offers the cheapest way to trade? Other factors including customer service, ability to open multiple investment accounts within the same brokerage umbrella, and access to different types of investments and research can all make the difference in deciding which brokerage — and which fees — make the most sense for your financial goals.

Bottom line

Online trading gives you the option of trading stocks in bed (or just about anywhere), on your terms. That can be a double-edged sword for some investors, who may feel like online investing gives a video-game quality to the stock market. Those investors may benefit from working with a financial advisor or full-service brokerage.

For others, online investing is a good way to build up confidence, learn investing basics and grow their portfolio to help put them on the path to a satisfying online investing experience.

The “Find a Financial Advisor” links contained in this article will direct you to webpages devoted to MagnifyMoney Advisor (“MMA”). After completing a brief questionnaire, you will be matched with certain financial advisers who participate in MMA’s referral program, which may or may not include the investment advisers discussed.