Many stockbrokers are able to offer a range of advisory, trading and discretionary fund management services to their clients. Execution only trading involves stripping their services to the core and using the broker for nothing more than buying and selling stocks and shares. Some stockbrokers offer execution only services as an option, others specialise in execution only services alone.
Execution trading has advantages and disadvantages. The great advantage is that they are cheap to provide. An execution only broker merely needs to set up a call centre to process dealing instructions has minimal compliance costs and has no liability for potentially bad decisions. As a result, execution only services offer a very cheap way to buy and sell shares. Unlike other broker services there is seldom a minimum transaction size.
Low cost, no minimum transaction size and simple transaction methods usually through a single phone call or by push button on an internet site mean that execution only services are highly attractive to small and inexperienced investors.
Good investors should however be aware of the limitations of execution only services. With execution only services the onus is entirely on the investor to do his or her own investment research. Research is important for good stock selection and a broker will often have access to information and insight not available to the individual investor.
A second danger lies in the simplicity of execution only dealing. Execution dealing can encourage active trading. It can place a small investor in a position where he or she does not understand his or her risk profile. For most investors a good stock selection buy and hold strategy produces a better return than a frequent trading policy which might be encouraged by low dealing charges. In Europe there is regulatory pressure that all broker services should contain an advisory element.
Another difficulty arises from the simplicity of the service. Execution only services do little more than follow buy or sell instructions. Once the instruction is given the execution order broker fulfills the order regardless of any adverse or favourable movement of the stock exchange. Those brokers that offer additional services typically offer stop loss and limit order facilities. Stop loss and limit instructions are designed to minimise the influence of stock market movements on the trade. Stop loss and limit orders are a particularly important tactic to minimise risk in the current volatile market conditions.
Another issue is scope. Execution only brokers tend to specialise in the larger more liquid shares. Their service may not be available to an investor who wishes to trade a less liquid stock, perhaps in a foreign exchange.
Execution trading is a useful cost effective means with which to buy and sell stocks and shares. It should be used wherever possible. However, a wise investor would do well to reflect on the relative advantages and disadvantages of the service.