Commission Trading: What Is Realistic To Pay? | Definition, Example, Rebate, Slippage Explained
It costs money to trade, and one of the costs is commissions to your broker. No one works for free, but luckily costs have gone down a lot the last two decades. What is a commission trading, and how important is it?
A commission refers to a fee imposed by a broker or investment advisor when executing trades or providing investment advice for clients in the securities market. The specific commission amount can vary across brokers, influenced by factors such as the traded asset and the type of service provided. Typically, brokers who solely execute trades without making decisions on behalf of clients or offering investment advice tend to charge lower commissions. If you are trading the most liquid assets and instruments, commissions (and slippage) are very low.
In this article, we look at commissions in trading: what it is, types of costs and commissions, no-commissions brokers, how to get “paid” (rebate) a commission, and how it affects your trading performance.
Some key takeaways:
- Picking the right broker for your investment/trading style is important;
- We pay cirka 0.015% for a round trip in commissions when trading high-priced and liquid ETFs; and
- Comparing backtests to live trading, we estimate a cost of 0.01% per round trip in slippage if we stick to the most liquid ETFs.
What is a commission?
Commissions are a fee to your broker for executing orders. For example, if you buy 100 shares of SPY, your broker charges you a fee for that and also when you sell. This is a round trip.
Some brokers offer no commissions, like Robin Hood, for example. However, such brokers make money in other ways and thus might not be a better option for you.
Additionally, you need to pay regulatory fees, exchange fees, clearing fees, or pass-through fees.
How each broker passes on these varies from broker to broker.
Related reading: – Different types of trading systems
Why a broker charges commissions
A commission serves as a compensation given to the broker for providing their services to you. By charging commissions, brokers cover the costs associated with offering their services, such as employee salaries, platform maintenance, and exchange licensing fees.
Obviously, if brokers were to eliminate commissions, they would need to find alternative revenue sources to sustain their operations; otherwise, they would not be able to remain in business. Therefore, when a broker advertises commission-free trading, it is important to understand how they make up for this and ensure that you are truly receiving a favorable deal. Unfortunately, this is not easy for retail traders with little experience.
In many cases, brokers compensate for the lack of commissions by widening the spread, which means you may end up paying more in the form of a higher spread than you would have paid in commissions. Additionally, some brokers may seek to earn interest on the funds you have deposited but are not actively using for trading.
While this practice is not inherently problematic, it is crucial to ensure that it does not impact the quality of the broker’s services, such as causing unnecessary delays when processing withdrawal requests.
Types of commissions? Examples
Some brokers charge a fixed fee per order, while othe