How to Open a Trading Account

In this section we will look at account types and how to properly open a trading account.

Getting Started

When you open an online account you will naturally have a number of questions. “What sort of account am I opening? Should I fund it from my bank account? I’d like to roll all my investments into one account. Can I do that here?”

Realize that every online brokerage account sign-up process is slightly different. Let’s focus on the key elements that are found in all major online brokerage firms to answer a couple of these quick questions that we think about it. “Should I fund it from my own bank account?” And the answer is, “Yes,” because of the requirements of the brokerage you must have any funds coming directly from your name and your name only into an account that is set up in your name and your name only. You cannot use a check from a friend in order to fund your account. The best way to fund your account is via a bank wire directly from your checking or savings account into your new brokerage account.

The type of account you choose will depend on whether your account is taxable or tax deferred which would be something like a 401(k), IRA, Traditional, Rollover, Roth or SEP. Is the account just for you as an individual or will it belong to you and your significant other or spouse? Which could mean it would be a joint account. Your choices include personal accounts, non-retirement, and under personal accounts you can open an individual account. Now this should be nonretirement, though you might want to open a joint account for you and your spouse or significant other. Possibly, you may consider, opening a custodial account which would be for a minor, perhaps your children or a niece or nephew. If it is not going to be a nonretirement account then we would be looking at a traditional IRA, Rollover, or possibly a hybrid like a Roth IRA or SEP which stands for simplified employee pension plan.

Cash vs. Margin

The next thing you have to decide is whether you’re going to use a cash or margin account. A cash account means that you can place trades for the investments using only the amount of money in your account. In other words if you place $10,000 in your account, you would only be able to spend $10,000 on any one position or number of positions. Until you close a position you would no longer have any more buying power. A margin account involves a line of credit from your brokerage firm and this allows you to buy stocks or other securities and/or options if you so desire. You also have the option of opening a margin account with options; realize that buying an option means that you are purchasing the right but not the obligation to buy or sell a stock at a specific price. You should know that options are complicated and only appropriate for very experienced investors of substantial means.

Cash Account

Remember, because it is a cash account, you are not allowed to borrow money. Depending on your brokerage, the settlement date for cash transactions may be as short as the transaction plus one day, but may go as long as the transaction plus three days. It is not like having instant T-0 that would be available in a typical margin account of a direct access trading brokerage.

Settlement Period

When we talk about transaction plus two or plus three we’re talking about the settlement. If I buy a stock on Monday and the transaction was at T-3, that means the whole thing is settled and done on Thursday at which point I would have the availability of any remaining cash available to me for further purchases. Depending on the brokerage many of them will offer you T-1. Very rarely will you see a T-2. The older ones and larger ones tend to use transaction plus three or T-3.

What is Margin?

Most brokerages will offer you margin for your trading account. Basically, you are given credit to purchase additional stock. With a margin account you are essentially borrowing money from someone, like getting investors into your trades. Remember, when you borrow, there is always going to be interest. Interest is paid only if you hold a position overnight. The interest rate that you pay is dependent upon the brokerages and varies slightly. Typically, it is 2% over the prime interest rate. Needless to say, you are responsible to pay this money back, regardless if you win or lose in your investing or trading. Because margin allows for you to profit more than you put in, you also risk that you could lose more than you put in.

Using Margin

Margin is set up in your brokerage account at 2:1 if your account is under $25,000 in total assets. As an example, if you were to open your account with $10,000, you would be able to purchase up to $20,000 worth of equities. Most brokerages today will offer you 4:1 intraday margin if you deposit over $25,000. Please note that this is for intraday use only and you must maintain 50% overnight. This can have some ramifications if you were to spend $100,000 on your $25,000 cash. Overnight means you hold the position past 4:00p.m. EST and you would be liable for a regulation T margin call and your brokerage would ask you to show them an additional $25,000 which would be 50% of the $100,000. To do this, it must be deposited in your account within five working days of their call and it must remain in that account for 24 hours. After 24 hours you can withdraw the extra $25,000, having shown them that you can honestly come up with the money if you were to borrow more than they allow.

Intraday Margin PDT

Let’s take another look at Intraday Margin which is often referred to as Pattern Day Trader Margin or PDT. An intraday margin is, once again, if you had $25,000 or more the brokerage will allow you up to 4:1 leverage. In other words, if you had $25,000 you can borrow up to $100,000 for the purchasing of stock. This is intraday, so overnight the margin may only be 50%. If you use all the horsepower of the $100,000 buying power you would have to close at least a portion of that trade by the end of the day or have to come up with a regulation T margin call.

Your Personal Information

As you go through the account opening process, your brokerage firm needs to know a good deal of personal information about you. The information is needed for account handling, tax tracking, and other purposes. Congress recently passed the US Patriot Act which requires brokers to collect and verify certain personal information. Investors are always required to provide accurate personal information about themselves. The brokerage needs all this information so they can contact you to discuss changes in your accounts to verify sales or purchases and to let you know about a margin call.

What is Needed?

Online brokerage firms have policies regarding your privacy and how this information is handled. Make sure you take the time to familiarize yourself with the brokerage firm’s rules for the handling of your personal information. The following is a list of the personal information a brokerage firm will likely collect:

Your full name, street address, phone number, e-mail address, Social Security number, date of birth, US citizenship status, place of employment, approximate annual income, net worth with or without your home, your federal tax bracket, and any previous market experience.

Realize they are required to know who they are working with and you need to be up front and honest with them. In answering their questions, be sure you answer them properly. A lot of people don’t think about how their net worth includes their television sets and automobiles. They almost always think about their positions and accounts but their net worth goes beyond that. It goes into all of their holdings and what their market value would be for sale on the street. The same is true about market experience; if you tell them you have zero market experience you may be doing yourself a disservice. Remember that if you do have mutual funds or a 401(k) or you have traded stocks before, even if it was with another brokerage, these kinds of transactions actually do count towards your experience level. Incorrect information could result in your being exposed to more risk than you can handle and therefore the loss of funds can be greater than what you can afford.

Additional Information

As always there is additional information the brokerage firm will also ask you. If you work for a registered broker dealer they’ll ask whether you were a director, a 10% shareholder or policymaking officer of a publicly owned company as well as which company that might be. If you are a registered representative of a brokerage firm or a 10% or more shareholder in a company, then you may have special disclosure obligations in addition to the information already provided.

Funding the Account

We talked briefly about funding the account. Your initial deposit can be made through an automatic transfer from your bank account. Most brokerage firms offer this service during business hours or by sending a check to the firm to be deposited. If it’s going to be a personal check, it has to have your name on it. You can open an account with existing stock bond certificates, transferring holdings from an account at another brokerage firm mutual fund, or bank; this is usually done through a form called the Automated Customer Account Transfer (ACAT). Most brokerage firms have a minimum deposit requirement for the opening of a new account; these may vary anywhere from as low as $500 to as high as $1 million. Most, however, offer cash accounts at a participation level of about $10,000. For those who wish to trade intraday margin of 4:1, the participation will vary between $25,000 and $30,000 to get the additional leverage.

Idle Cash

You also have to decide what is going to be done with your idle cash. Perhaps you have $10,000 and you bought $5,000 worth of shares of a specific stock, therefore you still have $5,000 of idle cash. You can ask your brokerage to have it pushed into different types of funds to earn interest for you so at least your money isn’t perfectly idle. These may include mutual treasury funds, mutual tax-exempt bonds, mutual primary funds, or even simple money market accounts.

Determining Your Suitability

Realize all this information is provided to determine your suitability to have a brokerage account. Your broker has a rule, Know Your Customer, and a brokerage firm must determine the investor’s ability to handle risk. This is usually broken down into four basic concepts.

  • 1. Aggressive growth means you’re willing to take extra risk in order to get extra rewards and you may wish to trade or invest in volatile securities.
  • 2. The next level down is simple growth that means you want to gain money in the account while preserving the original capital as much as possible and you can set certain levels of risk. “I want to do this but I don’t want to lose more than 5%,” and they would close the position if it went below that so you could only lose 5% if you choose that as your stop loss.
  • 3. The third one is called income and an income risk level means you intend to use the profits from the account as a source of income. Trades and investments are going to be bringing in small amounts of money and at the end of the month, so that your account balance remains basically the same, anything you’ve made for the month comes to you.
  • 4. The last one is the most conservative and that is capital preservation and this is where the investor intends to use the account for only one thing and that is to save and protect existing assets.

Almost Finished

We’re almost finished with understanding the parameters of opening a new account. Below is a typical understanding statement of what you are going to provide to the brokerage and what the brokerage is going to provide to you. You want to read everything that you sign and if you have any questions, please ask the brokerage prior to signing or sending any money at all.

  • I am of legal age to contract. I acknowledge that I have received, read, and agree to be bound by the terms and conditions as currently set forth in the BROKERAGE Customer Agreement and as amended from time to time. I ACKNOWLEDGE THAT MY BROKERAGE DOES NOT PROVIDE INVESTMENT, TAX, OR LEGAL ADVICE OR RECOMMENDATIONS. Under penalty of perjury, I certify (1) that my Social Security (or taxpayer ID) number shown on this form is correct and (2) that I am not subject to backup withholding because (a) I am exempt from backup withholding, or (b) I have not been notified by the IRS that I am subject to backup withholding or (c) I have been notified by the IRS that I am no longer subject to backup withholding (cross out item 2 if it does not apply to you). [The Internal Revenue Service does not require your consent to any provision of this document other than the certifications required to avoid backup withholding.]
  • I understand that Stadium Online will supply my name to issuers of any securities held in my accounts so that I might receive any important information from them, unless I notify you in writing not to do so.
  • I acknowledge that securities held in my Margin account may be pledged, re-pledged, hypothecated, or re-hypothecated for any amount due Stadium Online in my account(s) or for a greater amount. I UNDERSTAND THAT THIS ACCOUNT IS GOVERNED BY A PRE-DISPUTE ARBITRATION CLAUSE CONTAINED PARAGRAPH 31B OF THE STADIUM ONLINE CUSTOMER AGREEMENT.
  • Depending on the Brokerage involved an Electronic signature is sufficient – In other cases, the brokerage may have you print out the signature page and physically sign and mail in to them.
  • In either case, you need to print out the entire document for your records and keep a copy of any signature pages for the future.
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