When I was a young boy, I’d rarely hear the term ‘challenger’ (except in the TV show ‘Gladiators’). Nowadays, I hear it quite often. Many of the new digital banks, for instance, are known as challenger banks.
But what is a challenger, exactly? The term implies that there is an existing way of doing things and that it’s been that way for a long time – an incumbent if you like. It also implies that there is a newer, better way of doing things, and the new way is challenging the old way of doing things.
To understand what a challenger trading platform is, it helps to understand what traditional platforms offered, and still offer today.
But before looking at the differences, it may help to understand how trading platforms make money. Understanding this will help to explain why certain platforms operate the way they do.
How do trading platforms make money?
There are a few ways.
One of the most obvious ways is for a platform to charge a fee to execute the trade.
Some platforms, may also charge a monthly fee as well as a fee to execute a trade.
These are the more obvious ways.
A less obvious way is that trading platforms make money on the 'spread'. This works a bit like a currency exchange; the exchange will buy currency from you at one price, and sell it to you at a different (usually higher) price.
If google shows shares in BP are trading at 300p, chances are you'll be paying 302p per share.
Likewise, if Google shows shares are trading at 300p and you want to sell shares you already own, chances are you'll have to sell them at, say, 298p per share.
This is the reason that immediately after you buy a share, you will automatically be at a loss.
This difference is known as the spread.
A few pennies or cents may not seem much, but when you consider that people are buying hundreds or even thousands of shares at a time, all year round, you begin to see how lucrative this practice is.
The above points do not pose any inherent problems for Muslims, but the next thing does.
It's possible to borrow large sums of money to use to buy shares from the trading platform. This is known as leverage. However, unlike borrowing from a bank, you won't have to apply to borrow the money and then go through a stringent assessment. Leverage is available for pretty much anyone that wants to use the trading platform's money. Interest is usually charged overnight and the fees may increase over the weekend. This, in my view, has given rise to the day trader, who borrows money from the trading platform, trades with it, and tries to sell the shares for a profit before the market closes to repay the platform.
There may be a few other ways that platforms make money, but these are the main ways.
So, what are some of the differences between traditional platforms and challenger platforms?
Pricing
A big, obvious difference is the price.
In the case of X-O, they charge around £6 every time you buy shares, and another £6 every time you sell shares. And X-O is one of the cheaper ones!
If you were to trade with Hargreaves Lansdown, you’d be looking at around £25 dealing charges for buying and selling.
The challenger platforms generally do not charge a fee. In fact, they do not charge a monthly subscription fee, either. Therefore, they need to make their money elsewhere. This gives rise to something every Muslim needs to be wary of: CFDs.
If you’re familiar with the concept of a ‘loss leader’, then this will be very easy to understand. The challenger platforms absorb the cost of placing a trade (which is around £1). But once you sign up to their platform, they will then try to engage you in trading CFDs, which is a lot more profitable for trading platforms (where around 70% of people that engage in CFDs lose money). Judging by the growth of these challenger platforms, one can only assume that it is a successful strategy.
Customer service
With the traditional platforms, it is possible to speak to a human, often in the UK. The challenger platforms allow message-based communication. This could be via a chat facility, or by opening a ticket and waiting for an email response.
There is an implicit understanding that because customers are not paying monthly fee, or an execution fee, that the expectations need to be lower. And of course, staffing a call centre to take calls in the UK is hugely expensive; it’s far cheaper to have an email-ticketing system with staff based somewhere in the third world.
The more traditional platforms also operate like a bank in many ways. For example, HL may send statements, but platforms like eToro do not. If you really need one, you’ll have to ask them and then wait a few days to receive it.
Execution
One of the biggest difference I’ve found with execution is the 15 second price-hold. So, whatever price you’re interested in buying the shares for, that price will be held for 15 seconds for you. There is a countdown timer counting down those 15 seconds. This is massively different to how Freetrade does it. I have to say, the way Freetrade executes trades has to be the worst I’ve seen (yes, I know they don’t charge an execution fee, but even then it’s hard to find excuses for it). Suppose a stock is available to buy at your desired price and you go ahead and buy shares, you’ll almost always pay a price that Freetrade did not show. Now, if the price had gone down from when you decided to buy it, then great. But quite often you end up paying a higher price. The prices are not real-time and feels like a stab in the dark.
Signing up
I’ve experienced signing up with two traditional platforms and two challenger platforms so far: HSBC, X-O (both traditional), Freetrade and eToro (both challenger).
I have to give it to the challengers here- they on-board customers a lot quicker and painlessly. They allow customers to create a profile first and then provide the relevant documents later. Although it may not be possible to trade until verification is complete, it does allow time to get used to the platform and also have a go at trading virtually. Freetrade does not have a virtual account facility, but eToro does.
When I applied to open a HSBC account, it took a good few days to open the account. Even getting through to someone required waiting in the queue for about an hour. After that, it took a week or so to send through ID documents and get approved. In fact, HSBC were taking such a long time, I looked for alternative trading platforms. X-O also require documents before an account can be opened, but their response time was a lot shorter.
Range of stocks
One major difference, which may not be obvious from the outset, is that traditional platforms allow users to buy shares in more companies compared to challenger platforms.
Of course, it is possible to buy all the household names on the challenger platforms. So, the likes of BP, Microsoft, etc., are easy to find. But the lesser known stocks are seldom available on challenger platforms.
One reason for this may be that challenger platforms target the retail investor, and retail investors are more likely to be familiar with customer-facing companies compared to business-to-business companies.
If you feel like you’d still like some guidance on using trading platforms, consider joining my free 30 Day Trading Platform, where there is a module on using the trading platform.
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