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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.

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FrugalTrader About the author: FrugalTrader is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.

{ 16 comments… add one }

  • FourPillars July 24, 2007, 10:31 am

    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

  • savingDiva July 24, 2007, 11:19 am

    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.

  • nobleea July 24, 2007, 1:09 pm

    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.

  • Adventures In Money Making July 24, 2007, 2:06 pm

    In the US, IB charges only $1 for 500 shares or less.

  • moneygardener July 24, 2007, 5:50 pm

    I agree with 4Pillars.

    Personally I use a 2.0% rule.

    Commission divided by (Cost – Commission) = 2% is the max. I go.

  • Jason July 24, 2007, 7:00 pm

    I would have never thought of that. Thanks!

  • The Financial Blogger July 24, 2007, 9:26 pm

    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.

  • A.J. - IAmFacingMillions.com July 25, 2007, 11:47 pm

    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.

  • Blain Reinkensmeyer July 30, 2007, 6:39 pm

    Solid article Frugal! Will make a good read for my readers :P

  • Ed Rempel July 31, 2007, 2:41 am

    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

  • FourPillars July 31, 2007, 9:25 am

    Ed, did those active traders give any indications of their performance?

    12% mer is indeed shocking.

    MIke

  • MoneySheep August 4, 2007, 11:46 am

    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.

  • Tanady August 5, 2007, 5:39 pm

    Hello,

    Your blog are really well organized and full of information. Thank you for sharing… (smile)

    My name is Cornel Tanady, and have been doing some research about options trading.

    Kindly visit my blog to know more about options trading and comments will be greatly appreciated.

    Thank you very much.

    Sincerely,
    Tanady

  • Dividendgrowth February 12, 2008, 4:29 pm

    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..

  • Charles in Vancouver July 7, 2008, 4:54 am

    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.

  • Jay October 6, 2009, 12:01 am

    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.

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