Brokerage charges can appear complex. Even though these are mentioned at the time of signing on, many investors still fail to understand them. Whether you are a trader or an investor, it is crucial for you to conceptually understand these charges and their impact on your transaction.
What Is Brokerage?
Before you can trade or invest in shares, you must have a trading and a demat account in your name. These enable you to buy and sell shares on the stock market. The stock broking firm through which you buy and sell shares charges a fee for its service. This fee is what is known as the “brokerage”.
The brokerage charged by stock brokers is not fixed or regulated by any central authority. Thus, the brokerage charges across multiple service providers are not uniform or even consistent. The regulator has only fixed an upper limit for brokerage at 2.5% of the transaction amount.
Currently, in India, there are four different ways through which stock brokers levy brokerage charges. Let us take a look at each of them:
As the name suggests, in this mode, for every trade that you make, a flat fee is charged. Thus, irrespective of the traded value, the brokerage that you have to pay remains the same. However, this is subject to a condition that if the percentage brokerage is less than the lower amount is charged to the investor.
For example, a broker may charge a flat fee of INR 20 or 0.1% of the traded value, whichever is lower. So, if your traded value is INR 10,000, your brokerage will be INR 10 (10,000 * 0.1%), as it is lower than the flat fee of INR 20. This is so far the most popular method of levying brokerage on trades especially for discount brokers.
- Brokerage as a percentage of the traded value
Stock brokers charge a percentage of the total trade value as brokerage. Simply put, the higher the value of a trade, the higher the brokerage is likely to be and vice versa.
A few stock brokers have come up with monthly trading plans that allow you to place an unlimited number of trades in a month irrespective of the value of the trades. And in return, they charge a monthly or yearly subscription fee.
There are quite a few discount broking houses which do not levy any brokerage on the transactions which are delivery based (details below).
How is Brokerage Charged for Different Transactions?
There are typically four types of transactions that can be done while trading in the stock market on which brokerage is charged, namely:
1. Equity delivery
All trades in which you hold a stock for more than a day are said to be delivery based trades. Brokerage is charged on both the purchase and sale, on the trade’s value. However, as you would know, many brokers do not charge for delivery-based trades. But, before you jump with joy, hold your horses; we will explain this in a little more detail in the later part of the article.
2. Equity intraday
If you buy a particular stock and sell it on the same day, then the trade is considered as an intraday trade. Here, intraday brokerage is applicable on both buy and sale transactions. It can be expressed as a percentage of the transaction value or as a flat fee; for example, 0.1% of the turnover (Number of shares x price of the share) or INR 20, whichever is lower, per executed order.
3. Equity futures
You can buy stock futures (standardized contracts) and the money that you make or lose in a futures transaction is credited or debited to your trading account the same day. Here, the brokerage charges are applicable in the same way as equity intraday trades, i.e., expressed as a percentage of the transaction value or a flat fee.
4. Equity options
These trades are a significant part of the derivative market, particularly in India and act as a tool for protecting positions and reducing risk. Here, usually the brokerage charge is a fixed flat amount per order or lot. The brokerage charges for the above transactions differ from broker to broker. Apart from the brokerage charged, there are additional charges mandated by the law / exchange / regulatory authority, as mentioned below:
The above mentioned charges are applicable irrespective of which type of broker you choose, i.e., full service or discount broker (we will speak about the difference between them in the latter part of the article). So the only distinguishing factor across different brokers is the brokerage charged on different transactions.
Now let us understand how brokerage is calculated with the example of an equity delivery transaction:
Consider brokerage charges for equity delivery on buy and sale is INR 0.1% of the traded value.
When you take delivery of equity, you are a buy-and-hold investor (often also called a passive investor) looking to hold the stocks for the long term. Buy-and-hold investors are happy to wait for a longer amount of time to see the value of their investments appreciate because they are essentially investing in a stock to generate returns of at least 20% plus.
Assume on Sept. 1, 2020, you bought 100 shares of Reliance Industries at INR 1,000 per share for the long term. The total buy value is INR 1,00,000 (100 * 1,000). So, an amount of INR 1,00,000 plus brokerage of INR 100 (0.1% x
INR 1,00,000) and GST on it (@18% of INR 100 i.e., INR 18) totalling to INR 1,00,118 will be debited from your trading account.
After two years of holding the shares, you decide to sell them on Sept 1, 2022 at the current market price of INR 1,800. Now, an amount of INR 1,80,000 less brokerage of INR 180 (0.1% x 1,00,000) and GST on it @18% (i.e., INR 32.40) totalling to INR 1,79,787.60 will be credited to your trading account. So, the profit earned on holding Reliance Industries for two years is INR 80,000 and brokerage charged on the total traded value is INR 330.40 (INR 118 on buy + INR 212.40 on sale transaction).
You can see that by staying invested for two years; you generated an absolute return of 80%, i.e., profit of INR 80,000 on INR 1 lakh invested, of which 0.41%, i.e., INR 330.40 was charged one time as brokerage (including GST).
Now let’s assume the stock price moved up by INR 200 to INR 1,200. Now you earned an absolute return of 20%. Even then the one time brokerage (including GST) charged on the entire trade will be INR 259.60, which is just 1.3% of your profit earned.
You will notice that the higher the profit, the lesser the brokerage impact. However, it is a minimal cost when compared to the profit earned and service availed over the holding period. Thus, brokerage is negligible if you are an investor and this should not be a deciding factor, if you are a long term investor.
Other Differentiating Factors and Why Brokers Offer Zero Brokerage
New-age and fintech brokerage houses have been stressing on “zero brokerage” as their unique selling point and many of us, without even practically understanding its impact on the trade we make, get allured by it.
Before choosing a broker offering “zero brokerage”, we need to understand that the majority of such companies fall under the category of “discount brokers”. They are most known for providing you with the transaction platform to trade. Many do not offer certain services ranging from investment advice, research reports, assisted trading, etc., offered by full-service brokers. For instance, some services like “Call and Trade”, wherein you can place the transaction just over a call, are chargeable when availed via a discount broker and full-service brokers may offer these free of cost.
So, when you choose a discount broker, you are expected to have full knowledge of the stock market to make your own informed and research-backed trade decisions. This is the major reason why discount brokers are able to keep their operational costs low and offer slightly lower brokerage costs than full-service brokers.
One of the major reasons why discount brokers offer “zero brokerage” on equity delivery while keeping brokerage for the rest of trade transactions similar to full-service brokers is because the volume of equity delivery trades as compared to futures and options trades is miniscule.
Let’s look at this data for the month of August, 2022:
The data reveals equity delivery trades form 0.43% of the total market turnover while about 99% of volumes come from options trading. There are chances that you may get carried away with zero brokerage on delivery initially, and when you start trading in futures and options, you might actually end up paying a higher brokerage. In fact, around 75% of the equity market segment comprises intra-day trades.
Further, intra-day trading in options, full-service brokers often charge a flat fee on a per lot basis while discount brokers charge it on the basis of every executed order. Here’s why it matters:
Let us understand its impact with an example: Assume a full service broker charges INR 18 per lot and a discount broker charges INR 20 per executed order. Accordingly, if you buy two lots, the full service broker will charge INR 36 (18*2) whereas the discount broker will charge INR 20, since this transaction is considered as a single order. However, if you buy one lot, the full service broker will charge INR 18 (18*1) while the discount broker will charge INR 20.
Additionally, it is important that you first decide whether you are going to be a retail investor or an intraday trader. This is because, when you do intraday option trades, discount brokers charge INR 20 on both buy and sale transactions. This totals to INR 40. The full service broker will charge INR 18, only once, on the entire transaction.
Thus, it is for you to decide which broker to choose, based on your preferences and how you are going to transact.
When are Brokerage Costs Actually Relevant?
If you are a trader, you often trade in the market with the intention of making quick gains that are greater than the market average, based on short-term price volatility. Thus, you might enter and exit positions frequently over a short span of time. So here, brokerage may form a significant part of your transaction cost and should be accounted for while making a trade as it could take a big bite out of your returns.
However, it is to be noted that the charges are nearly the same for all brokers and could be negotiated as the brokerage charged by stock brokers is not regulated by a central authority. It is very important to determine which segment you will be active in. If you are going to undertake more futures and intra-day trades, then looking at delivery brokerage has got no meaning. The same is the case with traders who are going to be predominantly trading in Options; they need to look at what they would pay for the Options contract as brokerage.
It is of utmost importance that when you open a trading account, you look at the comprehensive picture of the brokerage charges. Along with this, your choice of broker should be influenced by your investment style, whether you’re a seasoned trader or retail investor; also an investor should not ignore the services which are offered by the broker.