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2019-10-06 07:00 by Karl Denninger
in Market Musings , 274 references Ignore this thread
So How Do They Make Money?
[Comments enabled]

Schwab has announced it is going to "zero commission" on stock and ETF trades -- right behind IB, which pretty-much did the same thing recently.

TD, E-Trade and IB got butt-pounded instantly, and Schwab is not reacting well either.

Now let's remember that these firms are allegedly "asset managers."  We're back to the same problem that the so-called social media have: They claim zero cost to you but that's not really true.

That ought to be obvious to anyone with more than two firing neurons -- you can't run a business making no money and remain in business.  Therefore the question becomes where is the money coming from and the answer is always "You."

In the brokerage business the issue has always been a function of order flow payments -- that is, the broker gets paid to route your orders to one place or another.  Why would someone pay for order flow?  Because they're making money off it.

Who's paying?  One of the parties in the transaction -- either you, the other guy (who was buying what you were selling or vice-versa) or, most-likely, both of you.

How are you paying?  Through the spread -- that is, the difference between the buy and sell.

There is an alleged thing called "NBBO" (national best buy and offer) that is supposed to prevent you from getting hosed.  That is, when you buy or sell a stock you're supposed to get executed at the best bid or offer in the market at that specific point in time. 

The problem is that high frequency trading -- robotic algorithms -- have made it quite possible to game this, presenting the appearance of compliance or even factual compliance while functionally gaming the market and stealing money from you by effectively front-running the transaction.  At the core of the issue is that the NBBO is calculated by a central party called a "SIP" and its latency is longer than the computer's -- by a lot.  As a result it's entirely possible for the machine to get "in front" of your order and there's no way to prove it did on a predatory basis -- but these firm's wouldn't exist, nor would any other private connection if it didn't work.

So don't kid yourself -- while this is pounding the online trading market companies today it does not mean you're not paying for your stock trades.

You are.

It's just that the price is being hidden from you and it is almost-certainly higher than it would be if everything was fully-disclosed.

After all why would anyone hide facts from you and claim to make something "free" if it actually saved you money?

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Bodhi
Posts: 1330
Incept: 2008-02-23

Canton, GA
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My assumption when these zero commission stock trades were announced was that all the stock firms were front running all the trades. You confirmed this for me. TANSTAAFL
Flappingeagle
Posts: 3289
Incept: 2011-04-14


Online
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Quote:
the answer is always "You."


Perhaps someone can shoot a hole in this argument but I have said for years that the only thing that is "real" is people, everything else is simply a tool used by people. If you want to make money, you have to buy and sell to other people.

Sure there are resources, tools, knowledge and machines but those are just used by people. You have to sell to someone else and that person either pays right away or pays over time, if they don't pay, you don't make money.

So of course the answer is "you", either the "you who is buying, the "you" who is selling, or both of "yous" (lol). The whole financial system is just a middleman who earns a cut for facilitating the transaction.

Switching gears a bit. It is a innate human trait to want something for nothing. In a lot of ways, that trait is what makes a lot of scams possible. Taking advantage of that trait they are when they offer zero commissions.

Flap

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Here are my predictions for everyone to see:
S&P 500 at 320, DOW at 2200, Gold $300/oz, and Corn $2/bu.
No sign that housing, equities, or farmland are in a bubble- Yellen 11/14/13
Trying to leave the Rat Race to the rats...
Burya_rubenstein
Posts: 1571
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How do we know that the firms charging a commission aren't also doing this?
Tickerguy
Posts: 159445
Incept: 2007-06-26
A True American Patriot!
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They are

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Winding it down.
Little_eddie
Posts: 1302
Incept: 2009-04-30

Delaware
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Back when I was trading, and one of the reason I stopped was that one of my brokerages started to not always do the trade at the moment I asked for it. My records showed the time I requested it, the final trade receipt would show a time of up to a few minutes later. When I back checked them I found that the trade was done on the high or low for that block of time and was always against me.

I can't find the spreadsheet I made at the time but in the end it just wasn't worth it anymore.

I sleep much better now.

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Think of how stupid the average person is, and realize half of them are stupider than that. - George Carlin

Oliver1655
Posts: 197
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Another day another extraction scheme and the sheep willingly take it.

smiley

I'm surprised there is not a shortage of these.

smiley
Inline
Joebtfsplk
Posts: 1
Incept: 2014-05-25

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These benevolent firms (Schwab, E*Trade, TDAmeritrade, Interactive Brokers aka IB) also do commodities where (surprise!) commissions are still charged.

Not only are commissions still charged -- commodity <B>margin deposits</B> represent a big pool of funds that brokers earn interest on (one example IIRC, $1.6 billion at MFGlobal when they failed). So there's another revenue stream for brokers (see following paragraph for mechanics on that).

If IB customers are long 1000 ES contracts and short 900 ES contracts, then we know IB is sitting on $13,167,000 in customer money (but typically much more). Since CME only requires that net exposure be posted with them (1000 long minus 900 short = 100 contracts @ $6930, or $693,000) -- that leaves $12,474,000 for IB can earn interest on every day.

And the percentage of retail commodity accounts (small traders) that end up losing is <I>at least</I> 90%. So how do we know the firms don't operate "house funds" that fade the little guys' net positions? Talk about *priceless* inside information!
Boodles
Posts: 6
Incept: 2019-09-25

Colorado
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I'm more familiar than I want to be with the bond trading world, (though I am neither a trader nor do I have a series seven.)

In recent past, bond trading firms would buy bonds to be sold by their in-house brokers. Brokers would be paid an extra dollop to unload these bonds on customers, usually large institutions but also "high net worth" individuals. Thus, brokers got not only the spread, which Karl mentions, but also the dollop built into the price quoted to the buyer. It was a good gig for the broker, not so much for the buyer.

After I figured this out, I avoided all brokers assiduously, knowing they'd be hawking items with a premium built in for them ... which I would indirectly pay for.
Mannfm11
Posts: 5602
Incept: 2009-02-28

DFW, Tx
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There is one good reason they put out these commissions. To get you to push the button more often. I have to explain to friends who go to casinos that they charge you, even when you win. I suspect they are hypothecating your money and lending your stock as well.

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The only function of economic forecasting is to make astrology look respectable.---John Kenneth Galbraith
Smacktle
Posts: 1975
Incept: 2009-01-20

Texas
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Everywhere you go, somebody is trying to get their hand in your pocket. Look at any bill or receipt.

My wife made me take her funds out of her TD Ameritrade account for other investment opportunities. She's a lot younger than me. I'm looking at pulling mine but the penalties are outrageous. I'm so close to the 59 1/2 mark. Not sure what I'm going to do.

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The faults of the burglar are the qualities of the financier.
- George Bernard Shaw

Reason: Mispelling
Mickey
Posts: 93
Incept: 2014-05-19

Chic
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I learned the lesson several times a long time sgo.

At least a decade ago i used two platforms. One JPM and the other Schwab. I had to use jPM because i was with a RIA firm that requires it but I transitioned accounts to Schwab, for the lower commissions, for which I was politely asked to stop doing that or leave, so I left.

Anyway, in addition to the commission difference, I saw a pattern where most if the time fills were higher with JPM. For trades done almost at the same time.

You would think that over time trades put in on two platforms at slightly differt time of a few seconds woukd average out the pennies. But no. JPM had higher commissions and fees ne arly all the time.

When I started out in 1999, i hung my license at a firm that charged around 250 or more for a trade paying me 40%. That firm has been gone for a long time, as was I, but the old timers pulled us youngsters aside to show us how to trade several trades a month for our profit. I was gone in a week, the fastest one ever to leave.

I picked up a client who was with a big firm, and had a portfolio full of preferred stock. They gave me all their old trading tickets. Ya see, the prior firm did not charge commissions or fees, but what i found was that the client always was buying at the high of the day, or higher, and sold at the low of the day, or lower.

At least now when I trade I can see the execution of the trade. Its still far from perfect. When i put in an order to buy or sell thats inside the spread, usually i immediately see the rest of the side i am on come to my price indicative of all the algo trading.

I just try to carve out my little piece of the world.
Macthor
Posts: 27
Incept: 2009-09-16

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Is this zero-commission policy only on market orders?

I've been out of the trading game for quite some time, but I remember extensively using limit orders. If I didn't get executed, cest la vie.
Mickey
Posts: 93
Incept: 2014-05-19

Chic
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By the way, zero commissions opens the door for a tax on trades.
Tickerguy
Posts: 159445
Incept: 2007-06-26
A True American Patriot!
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@Mickey - there already is one; it's a "SEC Fee" but it's a tax....

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Winding it down.
Ptjim
Posts: 415
Incept: 2013-06-26

Pacific Northwest
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Slippage is one of the reasons I always place limit orders; it fills at my price or I wait until it does and I don't chase it. Many more fish will swim under the bridge if one gets away.

And Macthor, the new commission-free trades apply to all types of orders for stocks and ETFs - at least at TD Ameritrade, which followed Schwab's announcement so I assume it's the same at all brokerages that jumped onboard.

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He has erected a multitude of New Offices, and sent hither swarms of Officers to harass our people and eat out their substance. - The Declaration of Independence
Tickerguy
Posts: 159445
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They're all getting paid for order flow, and then there is their "wealth management" service....

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Winding it down.
Ptjim
Posts: 415
Incept: 2013-06-26

Pacific Northwest
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Yep, they make money from order flow and from cash sitting in our accounts, but they have to make money to provide me trading services, so yay for capitalism.

I'm a TA trader, so if I get fills at satisfactory limit levels, I'm good and they're free to go off and make money from the transaction via other means. No longer having to cover round-trip (or higher, if I do partial sells) commission right off the bat before being profitable is a solid benefit that puts measurable lunch money back into my pocket since I'm a fairly frequent trader. I avoid market orders like the plague, used only on very rare occasions and never for spreads more than a few pennies and/or thin volumes.

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He has erected a multitude of New Offices, and sent hither swarms of Officers to harass our people and eat out their substance. - The Declaration of Independence
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