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Written by Matthew Cerminaro on August 16, 2020
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How Does Firstrade Make Money?

Investors have a lot of options today when it comes to how they invest in the stock market.

One of the most recent trends has been the switch from commissions on trades to commission free trading. However, that often begs the question of how these commission free brokerages make money?

With $0 commissions on all ETF and options trades, Firstrade is no different. Through their online platform and mobile application, Firstrade offers users 100% commission free trading. 

Firstrade, and other online brokers, make money in ways other than charging a commission. 

In this article I am going to outline the ways that Firstrade can make money through its brokerage service, even while forgoing these commission charges on investor’s trades. 

What Is Firstrade?

Firstrade was originally founded in Queens New York, in 1985.

Firstrade has evolved over the years to meet the growing demands of investors seeking to open online brokerage accounts. 

To meet that call, Firstrade launched an entirely electronic broker-dealer service that allows retail investors to execute trades at very low costs. And as of recent, for $0. 

In April 2018, Firstrade began offering $0 commission fees to meet a global shift to reduce the barriers of entry for retail investors. It has been offering competitive prices and services ever since. 

Now, onto the ways that Firstrade’s electronic brokerage service makes money. 

How Does Firstrade Make Money?

Rather than simply charging trading commissions to customers, Firstrade has found other more creative ways to make money. They may be making money in other ways too, but these are the common ways that these commission free brokerages earn a few bucks.

1. Margin Accounts 

Firstrade allows you to invest on margin. Margin is when you borrow money in order to finance an investment. This money, however, comes at a cost. 

Clients pay interest on this money loaned by Firstrade. Fees vary across brokers, with Firstrade’s margin rates ranging from 5.5% to 9.75%. 

Margin usage when investing is very much dependent on the individual’s risk tolerance. If you are taking on a lot of margin when investing, you are potentially being very risky. The ways margin can be used will be detailed below.  

Margin can be leveraged to increase position size at a level you would not be able to pay out of pocket. This can increase potential gains, but also mount to serious losses if not done correctly. 

If the investor takes on too much margin that it cannot repay if things go south, he or she may find themself in a very tough situation.

Bottom line, always be careful if you do decide to take on margin when investing. Your investment gains must cover the cost of the interest payments on that margin, and then some, in order to generate returns. 

After all, this is a big reason why Firstrade can make money by providing its services. When you as an investor mess up and over-leverage, you still owe an interest payment to Firstrade. 

2. Foreign Transaction Fees 

Firstrade requires its clients who are investing from outside the United States to pay a 3.0% fee if they decide to do business with them. However, if your money arrives in USD you do not pay any fees. It is probably cheaper to swap currencies at your bank before sending it to Firstrade.

This fee covers the cost of conversion into the US Dollar while also leaving a small margin of profit for themselves. 

While Foreign Transaction Fees are common for many brokerage firms, Firstrade’s fee of 3.0% must be compared to TD Ameritrade’s 0% transaction fee on its account funding. 

This is something to keep in mind if you are currently operating in a foreign country but would like to invest with a US-based brokerage service.

The fees may be steep for some, but it is all up to the individual investor’s judgment in determining if this fee is too steep or fair. 

3. Interest On Cash 

Believe it or not, Firstrade earns interest on the uninvested cash sitting in your brokerage account. While this may not seem like a lot of money, when you consider that they have millions of accounts, it does add up.

Firstrade takes the money that you deposit and gains interest in other ways with it. Their business model is similar to a commercial bank in the sense that it takes your idle money and puts it to work. 

Whether financing other margin calls, or buying bonds (which yield fixed interest payments for the brokerage firm), the excess cash across all of the accounts that it manages adds up to a pretty penny. 

This is a huge way for Firstrade to make up for what it loses in charging $0 commission fees on its trades. 

4. Market Maker Spreads 

This last method discussed is a bit more complicated and remains less publicized by online broker’s that charge no commission on their trades. 

The best way to explain this is by giving an example: 

  1. You place an order to sell a stock at $5.00.
  2. Firstrade receives this order and sends it to a “market maker." This is a large financial intermediary (middleman) involved in transactional purchases. 
  3. The market maker buys the shares that you want to sell, at the price you want to sell them at, and resells that stock to someone looking to buy it.
  4. The difference between the price that they buy your share, and the price they sell it to another is called a “spread."

After clarifying that, it begs the question “so how does Firstrade make money?” After all, isn’t the market maker the only winner in that transaction? The market maker is, after all, the one receiving the profit that arises from the “spread?"

These market makers have very close connections with their online brokerages and often incentivize them by offering rebates. Firstrade’s main market makers will offer them cash incentives to keep directing order flow to their firm. 

They will also pay them fractional margins within their spread that will help Firstrade make money on the spread as well. 

Say the spread that the market maker can drive through its transaction totals 5 cents. The market maker will pay a fraction of this “spread” to Firstrade so both parties are happy. 

There is a huge takeaway from this that every investor should bear in mind. For every purchase that you make of a stock, there is always a seller. And vice versa. For every stock that you decide to sell, there is always a buyer. These market makers allow us to have this liquidity we have come to rely on. 

Investing is a zero-sum game. If you are going to sell or buy a stock, an individual, company, bank, financial intermediary, someone is on the other end. 

Other Fees 

Firstrade offers services that involve market experts that can assist your decision-making process when investing. 

These services come at a premium, however, and are another way the Firstrade can make money through their service. 

A broker-assisted trade will be conducted at a commission of $19.95 commission. This number may be high to some who are looking for cheap ways to finance their investment ideas, but it comes down to the assistance that you are seeking. 

The $19.95 is another way that compensation is brought to the employees of Firstrade and a way the brokerage service can cover themselves by offering $0 commision on non-assisted trades. 

Now onto some final thoughts and my general overview after breaking down Firstrade.

Final Thoughts

Though it may seem hard to find ways that Firstrade makes money from the outside, internally Firstrade finds ways to drive revenue. 

By offering services like $0 commission to their clients, they are incentivizing the average retail investor to use them as their brokerage service. 

Utilizing a high volume of transactions, the penny’s that Firstrade can scrape from its large amount of accounts that it handles adds up for the online broker to make money. 

Also, it puts your money to work when you have idle cash laying around. Another way that the broker makes money. 

This platform provides a way for its clients to invest at a cheap cost relative to other brokerage services that have brokerage fees associated with their trading transactions. Investors can seek comfort in the online broker’s high ratings from various sites that review online brokers.

The overall sentiment regarding Firstrade is positive. Its business practices and ways it makes money seem to be ethical, sound, and fair for both the client and themselves.

Keep Reading:

Article written by Matthew Cerminaro
Matt is currently attending Union College pursuing a Bachelor of Arts in Economics. He participates in the student investment fund and is a member of the Union College football team. Matt runs his own personal finance Instagram page and market-related blog where he writes about economics and general wealth accumulation tips.

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