How is it possible to offer commission-free stock trading? And why it is bad for investors

Commission-free trading is not as great as it might sound. In the United States the costs are offset by Payment For Order Flow (when your brokerage sells your order to a market maker, bypassing the stock exchanges), but that's banned in many other countries. Find out how it's possible to offer commission-free trading in countries that allow or ban payment for order flow, and why commission-free trading could ultimately be bad for many investors.
00:00 Intro
00:12 Payment for Order Flow
01:05 History of trading commissions
05:30 The Bid-Ask spread
09:40 Example of market making
11:50 Net Interest Margin
13:35 Currency Conversion Fees
15:35 Is commission-free trading good?
17:14 Investors trading for free taking more risk
WATCH MORE OF MY MOST POPULAR VIDEOS:
When does renting make more sense than buying a home?: • Renting versus Buying ...
How to calculate your Net Worth: • How to Calculate Your ...
How to find more money to save: • How To Find Money To S...
My podcast about "Mostly Money" things: www.buzzsprout.com/5821
ABOUT ME: I've hosted a personal finance TV show on the Oprah Winfrey Network, used to be a stockbroker, went to school to become a racecar driver (failed), founded a fintech company that provides financial planning software to financial advisors who want to help more people who don't have lots of money, and I consult with wealth management companies on commercializing applications of behavioral finance. I'm also quite fond of donuts.
SUBSCRIBE FOR MORE VIDEOS LIKE THIS: kzbin.info?...
MY BOOK TO LEARN ABOUT THE BASICS OF PERSONAL FINANCE: www.amazon.ca/gp/product/0143...
FOLLOW ME ON TWITTER
/ preetbanerjee
WEBSITE: www.preetbanerjee.com
#MoneySchool #PersonalFinance #LearnAboutMoney #LearnToInvest #money #stockmarket #finance #howtoinvest #budgeting #budget #savemoney #insurance #financialplanning

[@jdavid1707]

wow!! fabulous dissertation Preet. learned a lot. and the ending? it is well worth the wait. cataclysm indeed.

[@yr1009]

You've explained it so well Preet.

[@johnsamuel1999]

Great video! This was easy to understand

[@skrmacs4815]

thanks Preet.

[@qosmioamit]

I was blown away as always by your style of simplifying complicated concepts. Thanks a ton!

[@PreetBanerjee]

Thanks Amit!

[@CJinsoo]

Peter Schiff discussed this with robinhood and gamestop, butyouprovide clearer explanation. your videosareoutstanding

[@bdkoz5262]

Thank you for the video Preet, I have been wondering how this worked for a long time.

[@PreetBanerjee]

You’re welcome - thanks for watching!

[@djinghost]

Great explanations. Brokerages that charge a fee per trade is a very good deterrent. It would stop someone from trading often, since the cost per trade adds up significantly over time. Commissions free trading removes the deterrent which could lead to some pretty bad outcomes. Delayed gratification is better than instant gratification when it comes to investing.

[@NeptuneKnives]

That's why I see a penny difference on my history 😳 Freaking awesome videos

[@mohamedlaminksmara759]

Hi thanks for the history and background information on commission free trade. However do you have any video on value stock and small cap stock.

[@PreetBanerjee]

Not yet - stay tuned 😊

[@PreetBanerjee]

Not yet - stay tuned 😊

[@mohamedlaminksmara759]

Thanks will hanging there.

[@teenidol18]

I still don't understand what ECN fees are and why market vs limit orders change the amount I pay in ECN fees. I understand it has something to do with adding or removing liquidity, but I can't seem to strategically place my orders in a way that I'm obviously reducing my own fees.

[@PreetBanerjee]

Placing a limit order adds liquidity to the security because people are basically saying "hey I'm willing to buy/sell at this price right now". When you add up a bunch of those orders, you get the order book you might recognize if you've seen level 2 quotes. Placing a market order, which would get executed right away at the best prices offered in the order book takes away the ability for someone else to execute that specific execution (reduces liquidity). Of course, with a heavily traded stock and many orders being entered/removed all the time, not really a huge deal as there might be many more similar orders out there at the same time. But adding liquidity can be incentivized by an exchange by paying a small per share fee and removing liquidity can be charged a small per share fee. This is known as the "maker/taker" model. I'm not sure I would let ECN fees influence my purchases unless I was trading EXTREMELELY high volumes of stock as the per share charges are pretty small. Even a trade for 500 shares is going be, what, $1-ish in ECN fees if you use a market order? Using a non-marketable limit order therefore isn't going to save you much, again at least if you are not trading incredibly high volumes. So the costs are not really enough to influence trading in most retail investors' case, and personally I default to using limit orders anyway, but not because of the small cost savings.

[@Amir-jn5mo]

Thank you for the informative video. I want to ask, i still don't understand why not having PFOF specifically hurts Canadian investors more. From what i understand the reasons for Canadian investors paying steeper prices are currency conversion fees (if they are trading US listed stocks) and slightly worse ask-bid spread?? but i feel like the whole PFOF can be abused by private market makers so i wouldn't mind taking that slight increase in ask-bid spread if it means the broker has to facilitate trades through the stock market. Wanted to ask your thoughts on this. For me personally since i am only buying and holding VEQT for the foreseeable future, the currency conversion fees and ask-bid spread doesn't matter too much since i can't think of anything that would be more liquid than vanguards all in one etfs.

[@PreetBanerjee]

These are separate issues. PFOF not being available in Canada is generally a good thing and the trade offs you mention are probably good trade offs, especially if you don’t trade often. The economics of offering commission free trading in Canada are much harder though because that revenue source is not available for Canadian listed stocks. And because more active Canadian traders likely trade US listed securities, not being able to hold us currency between trades could be a significant cost (this is in comparison to a brokerage that could allow you to hold us cash and even after factoring the explicit trade commission).

[@CJinsoo]

Robinhood pulls in the instant gratification “investor.”. these are not investors. to paraphrase Warren buffet quote, “the daily stock market is a voting machine. long-term it is a scale.”

[@James_48]

I don’t understand the value of comparing the fees in today’s dollars while excluding the notion that my stock purchase would also be in today’s dollars. I will always think of the trading fee as a percentage of the total transaction. In your example wouldn’t that $3,000 purchase in today’s dollars be $12,753? So the $204.05 fee is still 1.6% of the trade - isn’t it? Or am I missing something? Don’t get me wrong, I pay $10/trade and I’m happy to do so.

[@PreetBanerjee]

Flat rate commissions weren’t around back then so if you placed a trade for more shares the commission would be higher as well. I’ll check the commission guide back then when I’m by my computer and calculate what it would have been .

[@James_48]

@@PreetBanerjee thanks Preet. Learned a lot from this video and subscribed!

[@PreetBanerjee]

@@James_48 Minimum commission schedules changed quite a bit for NYSE before May Day, but here's an example: March 24, 1972 to September 25, 1973 Share price -> Minimum for orders of 100 shares $1 to $8 -> $6.40 + 2% of amount traded $8 to $25 -> $12 + 1.3% of amount traded Over $25 -> $22 + 0.9% of amount traded (with a $65 maximum) I don't know what the average trade value is for a retail investor off the top of my head, but assume it's $5,000 today then back in 1973 that would be $802-ish. And assuming a share price of $5, you could get a board lot of 100 shares for $500 (odd lots I think could cost up do double), so let's use $500 as a more typical trade value. You'd pay about 3.3% of that trade. Placing a $1,000 trade back then, to get a board lot you'd need a $10 share price, so you'd be at 2.5%. But beyond the above schedule, if you traded multiple round lots, each extra round lot of 100 shares was another $6. If you want to dive deeper into it: www0.gsb.columbia.edu/mygsb/faculty/research/pubfiles/4048/A%20century%20of%20Market%20Liquidity%20and%20Trading%20Costs.pdf

[@James_48]

@@PreetBanerjee Wow, thanks for the detailed reply, I really appreciate the insight. I only started trading in 2015 so I was not familiar with all the previous machinations of fees.