Individual stock trading has exploded during the pandemic with the rise of meme stocks, investing FOMO and free trading platforms. New investors poured money into stocks looking to make a quick buck, and in most cases the markets obliged.
Indeed, Canadian and U.S. stock returns have soared since the brief market meltdown in March 2020. If you started investing recently, you could be forgiven for thinking that trading is easy. But investors can learn and improve while they trade, even before the next bear market rears its ugly head and teaches some painful trading lessons.
Frequent trading can quickly eat away at your portfolio gains. This article shares pro tips for managing your trading costs, including how to avoid emotional trades.
Are your free trades really free?
It wasn’t long ago that Canadian investors had to pay $29 per trade to buy and sell stocks at the big banks’ discount brokerage arms. Online brokers came along and helped drive costs down to about $5 to $10 per trade. More recently, Wealthsimple Trade became Canada’s first commission-free trading platform.
If you trade frequently, paying a commission every time you buy or sell a stock can add up. A good rule of thumb is to make sure your trading fees do not exceed 1% of the transaction. For example, if your broker charges $10 per trade, then make sure you buy or sell at least $1,000 worth of stock.
What if you use a free-trading platform?
It’s true that Wealthsimple Trade has $0 trading fees. But you will pay a fee if you want to purchase a stock that trades on a U.S. exchange, like Apple (NASDAQ: AAPL). That’s because Wealthsimple Trade doesn’t allow its clients to hold U.S. dollars in their account, and it charges a 1.5% currency conversion fee every time they buy or sell a U.S.-listed stock or ETF.
To put that in dollar terms, that’s like paying $15 on a $1,000 stock trade. That also exceeds the 1% rule I mentioned earlier.
Canadian vs. U.S. listed stocks
New investors are drawn to U.S.-listed stocks because of big names like Tesla, Apple and Amazon, or meme stonks (an ironic misspelling of “stocks”) like GameStop and AMC. But beware of insidious fees like foreign exchange when trading in Canadian dollars.
When you place a trade for a U.S.-listed security in your Canadian-dollar account, your brokerage will automatically convert that transaction into U.S. dollars. As with Wealthsimple Trade, investors typically pay about 1.5% to convert loonies to U.S. dollars at most other brokerage platforms—but most of them also allow investors to hold U.S. dollars. That means investors can sidestep expensive currency conversion fees in their trading account by funding the U.S.-dollar side of their account and then trading U.S.-listed securities from there.
The best way to convert Canadian dollars to U.S. dollars (and vice versa) is a technique called Norbert’s gambit. Justin Bender, portfolio manager at PWL Capital in Toronto, shows investors how to perform Norbert’s gambit on several investing platforms—watch the video tutorials on his Canadian Portfolio Manager blog.
Norbert’s gambit involves using the Horizons US Dollar Currency ETF (DLR). Bender says that this ETF—which is equivalent to holding U.S. cash—is available in two versions. Both trade on the TSX, but the first, with the ticker symbol DLR, is bought and sold in Canadian dollars, while the second, DLR.U, trades in U.S. dollars. You can use these ETFs to exchange Canadian dollars for U.S. dollars and then use the proceeds to buy U.S.-listed securities.
Which account types to use
As many new investors have discovered, opening a non-registered (taxable) trading account is fast and easy. Moreover, some investors wisely use a non-registered account for the “explore” part of their “core and explore” portfolio.
The challenge with using a taxable account for your day trading adventures is that you need to keep meticulous records of your transactions. Don’t expect your brokerage platform to do this for you.
Every time you trade in a taxable account, you create a taxable event—either a capital gain if you made money on the trade, or a capital loss if you weren’t so lucky. And if any of your stocks pay dividends, that’s taxable income as well.
Traders need to keep track of their capital gains and losses, as well as their investment income. They also need to track their “adjusted cost base.” If you buy shares of the same stock over time and at different prices, you’ll need to track the average cost. Failure to do so will cause a huge headache come tax time.
If you have a non-registered account and aren’t too savvy with spreadsheets, then I recommend the website adjustedcostbase.ca, where you can calculate your adjusted cost base and capital gains for free using its online tool.
Learn about ETFs
Sure, it’s exciting to trade shares of your favourite individual companies. But, as we’ve already established, it can get expensive to buy and sell individual stocks on a regular basis. Think about how many stocks you’d need to build a truly diversified portfolio. And while you may be able to properly diversify across the Canadian market with 20 or so stocks, that still leaves the rest of the world’s stocks untouched.
More than that, there’s little evidence supporting day trading or stock picking as a profitable long-term activity.
A better, cheaper and more diversified way to invest is by using low-cost ETFs. Investors can purchase broad-market ETFs with management fees starting as low as 0.03% to 0.06%. For example, the Horizons S&P/TSX 60 Index ETF (HXT), one of the least expensive ETFs in Canada that offer investors exposure to the performance of the large-cap market segment of the Canadian equity market, has a management fee of 0.04%.
Another ETF advantage is that several online brokers now offer commission-free ETF trading. Broad diversification, low fees and no commissions—what’s not to love?
One of the best lessons new investors can learn is that trading stocks is more difficult than it has been over the past 20 months. There are hidden fees and trading costs, and taxes that can add up for frequent traders if they don’t pay attention.
Finally, understand that successful investors should aim to diversify broadly with their core portfolio. ETFs are great building blocks. Frequent stock trading should be reserved for the “explore” part of the portfolio—and always be mindful of fees and taxes.