The 1% Stock Trading Rule
I mentioned in the Questrade Review comments about the 1% stock trading rule. I'm sure that some of you seasoned investors and traders alike know about this rule, but I'm going to explain it for the people that are fairly new to the investing world.
I first learned about this rule from fool.com, and it basically states that: Your trading commission should never exceed 1% of the value of the trade. The reasoning for this is so that your trading commissions don't eat into your profits too much. Basically the same reasoning for picking LOW MER mutual funds/ETF's.
For example, say you have an account with a big bank brokerage who normally charge around $30/trade. If you were to follow the 1% rule, the minimum trade that you should make is $3000 ($30/1%). If you have an account with Interactive Brokers ($2 for < =200 shares) and the trade is less than 200 shares, then the minimum trade amount would be $2/1%=$200.
As you can see, if you are just starting out and have a low balance, it would make sense to go with a cheaper brokerage due to the fact that you can diversify with your cash, even if it means buying smaller quantities.
Moral of the story? If you want to maximize your returns, try to pay as little as possible in commissions. If you haven't already, check out my Canadian Discount Brokerage Comparison article to get a general idea of what's out there.
[…] Million Dollar Journey has a good quick description of the 1% rule. https://milliondollarjourney.com/the-1-stock-trading-rule.htm […]
I didn’t know about that rule before I read it on your site, but then again, I’m not a trader.
I think it’s a pretty good rule to follow, especially if you are a frequent trader. However for someone who is a long term investor I wouldn’t worry too much if you go a bit higher the odd time.
Another way to think of it is to consider the “MER” of your purchase. If you are buying a stock and planning to hold it for 10 years then you could conceivably buy a small amount ie $500, pay $20 in commish (buy & sell) which is 4%. This may seem excessive but if you consider it on an annual basis, it’s only 0.4% based on the original trade amount. If the stock goes up then the “MER” will go down a bit.
I’m not trying to justify higher costs since the costs should be kept as low – only that we should keep costs in perspective and don’t let fees be the main driver of our investment plans.
Mike
Since I don’t frequently invest $3000 in a single ETF, I like Sharebuilder ($4/trade). I’m also interested in trying Zecco for free trades.
FT;
Shouldn’t both buy and sell commissions be included? It’s unrealized gain unless you can sell the stock, so the sell commission should be included as well.
I don’t put a huge emphasis on commissions, though, looking at all my trades, they are under 1% when buy/sell commissions are included.
In the US, IB charges only $1 for 500 shares or less.
I agree with 4Pillars.
Personally I use a 2.0% rule.
Commission divided by (Cost – Commission) = 2% is the max. I go.
I would have never thought of that. Thanks!
Like FP, I didn’t know about this rule. Quite interesting for a day trader. However, if you buy for long term, this should not affect your overall yield too much.
Cheers,
FB.
I don’t necessarily agree. If you are an active trader, definitely. If you are a buy and hold type investor and plan to be into the stock for a few years, then paying more than 1% isn’t necessarily that bad of a thing.
Now, that said… I would suggest that anyone who cannot put at least $500 into EACH stock trade should probably NOT be picking stocks on their own and should instead consider a mutual fund.
It simply isn’t cost effective to spend a lot of time learning about stocks, watching them, etc. to make micro trades.
But most importantly, I’d rather see a person invest $100 in a solid blue chip stock with a $4 or even a $8 commission than not save $100 at all.
[…] Interactive Brokers has reduced their minimum commissions for Canadian trades from $2/trade (200 shares) to $1/trade (100 shares). Great news for small time traders like me. Check out how this new fee schedule can affect the 1% stock trading rule. […]
[…] the 1% stock trading rule @ million dollar journey, how much should you be paying for trades? – there are some good comments on this post as well […]
[…] Million Dollar Journey talks about the 1% stock trading rule. […]
[…] up a strong topic for his submissions to the 111th Carnival of Personal Finance discussing the 1% Stock Trading Rule. I like this simple rule especially for new traders who may not have a lot of money to invest with, […]
Solid article Frugal! Will make a good read for my readers :P
While I don’t buy individual stocks, this is interesting. I have talked to some active traders who get their costs down to 1% for both buy and sell.
However, they turn over their portfolio about once/month. A 1%/month cost equals a shocking 12% MER!
This is one of the reasons why almost all active traders lose money in the long run.
Ed
Ed, did those active traders give any indications of their performance?
12% mer is indeed shocking.
MIke
[…] Money has hosted the latest Carnival of Personal Finance. My article on the 1% stock trading rule was featured as a 2nd stage […]
Before buying or selling (using an agent), you should analyze this: “Do this for me, I will give you 2% of my asset, is this reasonable?” The answer depends on your knowledge about the agent. The know-nothing person will probably say it is ok. If you know the agent takes no effort at all, and your data (say, from the annual report of the agent/broker) shows that their profit from doing this is huge, you know you are being taken advantage of, they can cut down their fee. Canadian don’t stand up for being gouged, so the financial institution keep milking the cow.
Another thorn is the real estate industry. Do this for me, I will give you 7% of my asset.
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One way to follow this rule is to buy index mutual funds like S&P 500 ones, which have low annual expense of 0.1%. Or if you must do your own stock selection in US, you can sign up for Zecco – 10 free trades per month is more than you need as a passive investor..
Dividendgrowth: Again, this is a Canadian blog, and Canadians do not have access to American brokerages such as Zecco. Even when we buy US stocks we need to use brokerage with Canadian operations.
[…] This would help reduce transactions which in turn reduces trading costs. For me, I use the 1% trading rule. That is, the purchase commission should never be more than 1% of the total transaction […]
an interesing rule, but very valid. i never really looked at it before, however since i am active i will definitely pay more attn. that being said my trades are always in the thousands so i don’t think this really applies but i think it could effect the sort of stradegy you employ when u trade. i was reading about this one dood, who made very small day trades for a small profit, typically anywhere btw 25 to 180 each. he paid a 10 fee per trade. if he paid a 30 it would severely cramp his style.