Everett

Commissions have been dropping rapidly since the advent of Internet trading. So, a logical question for a customer is to ask how do the deep discount brokers, such as DLJDirect, E*trade, Schwab, some charging as low as £10 per execution, make any money at all? Take it from me, the cost to provide employees, real time data, clearing, and Super Bowl advertising creates a cost basis more than £10 per trade. The answer can be found in two customs practiced throughout the brokerage industry called "trading against order flow" and "payment for order flow".

For instance, take a firm with a big market making operation (such as eSchwab or DLJDirect). They receive an order from the customer and direct it to their market makers, who are in turn directed to trade against it for a profit. The market maker goes to the open market, and tries to bid for less than your limit price (if your order is a buy), or offer it for more than your limit price (if your order is a sell). In a fast moving market, the market maker may wait to execute your order until it is most favorable to his trading profit, giving you the worst execution possible at that moment. At the very least, the market maker tries to make "the spread", usually 0.0625 or 0.125 (sometimes much more) depending on the liquidity of the stock. If you are trading 1,000 shares, that amount adds up to £62.50 or £125 respectively. Have you ever been on the receiving end of a lousy execution? Have you ever noticed that your discount broker gives you a report at the same exact moment that your stock has halted its momentum, or reversed? This is no coincidence.

In the other case, a firm that either does not have a big market making operation, or does not make a market in your particular stock (such as E*Trade) will direct your order to another firm that does make a market in your stock. The receiving firm will then kick back revenue to the deep discounter for the opportunity to trade against your order. Payment for order flow can range from 1.5 pennies per share to over 4 pennies per share (that is £15 to £40 on that same 1,000 shares).

How does that £10 commission sound now?

Also, if you read your customer agreement with that broker, you will find in fine print that they disclose their participation in payment for order flow and trading against your order. You will be surprised.

I would never recommend placing a Market Order, as Market Makers will most definetely take advantage of you and sell you stock at a bad price, tell me it never happened to you?

That's why I use a Direct Access broker. When looking for an online broker I recommend asking the company if they offer Direct Access to the exchange.