Charles Schwab also dropping trading commissions to 0!

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12

Yuval,

This is a great question. I believe we (all of us) can get some answers with a little research. But I do not think we can find all of the answers—with me being the last to learn everything. Much of this you already know.

First, there is some limit to how far they can extend beyond the BID/ASK spread on your order. They are required to fill your order within the BID/ASK spread (NBBO)—for the amount on the order book at the time of the order. As you know NBBO stands for the National Best Bid and Offer. I think they meet this obligation (as far as I know). Of course, if the book has only 100 orders at the prevailing ASK (for a buy order) then only the first 100 stock are bought at the prevailing ASK under the regulations. Your next 100 (or whatever number) can then be filled at the new ASK according to the regulations.

As far as I can tell we can do a little better (sometimes) in the following ways (probably not an exhaustive list).

  1. Some brokers have access to (and give you access to) dark pools and some part of your order can be filled between the bid and the ask.

  2. Fidelity (as an example) has market makers who will fill at the prevailing BID or ASK beyond what is required by NBBO (will fill at the BID or the ASK for more than the number stocks on the book at that that price). They are nimble enough with enough access to dark pools and multiple exchanges (with computer assistance) that they can still profit by doing this.

  3. For VWAP orders the market maker will try to “Make” liquidity. When they do you get a savings and they keep the rebate for being a “Maker” and not a “Taker” (of liquidity). Many exchanges offer a rebate (which is usually not passed onto the trader) for “making liquidity.”

There was publication of results of price improvement in the past (IB did not participate). Charles Schwab has done well regarding price improvement historically (as has Fidelity).

For limit orders: try routing through NASD. This is anecdotal so try it is my only recommendation. See this link for a limited (and old) reference of the NASD routing of limit orders for retail investors: https://www.finra.org/rules-guidance/notices/94-58. While old it does show that NASD has made efforts to protect the retail investor.

Finally, I think IB charges a commission and makes a profit from your trades in other ways too. IMHO, you have to get the high volume discounts, get some of the rebates (“Maker” of liquity) and be savvy regarding routing and ALGOs for IB to work for you.

I think SUPirate1081 is savvy and makes IB work for him: he tries to be a “Maker” and collects a rebate for doing this when possible. Maybe he will comment again (updating and correcting some of my impressions).

Would love any corrections or additional information. For now I like Charles Schwab for simple orders.

It goes without saying that whatever I think I know now could change with the commissions war.

As far as how brokers can profit through payment for routing, that takes no imagination. They just pocket the payment. How do the people who pay for routing profit? It would take a lot of imagination to figure out how they wouldn’t if they have access to enough dark pools and large block orders that are to be filled over an extended period.

-Jim

13

This is a good point, but do the large brokerages even really care about trading generated revenue anymore? In 2018 8% of Schwab’s total revenue came from trading activity, 57% came from “Net Interst Revenue”. From their 2018 annual report "Schwab’s primary source of funds is cash generated by client activity which includes bank deposits and cash balances in client brokerage accounts. These funds are used to purchase investment securities and extend loans to clients. " Trading seems to be just a dangling carrot to get their hands on their client’s idle cash in other to use it for loans and buying bonds and higher yielding assets.

14

Cary,

This is an interesting point. I do not know the answer to this question. But are they acting a little like a bank? A bank making at least some risky loans (e.g., margin loans). Is there a concern?

What part of our account is insured? Will we be looking for a bailout in the next crisis? I guess Goldman Sachs got a bailout in the last one. But also MFGlobal did not make all of their clients completely whole, I think.

I am probably missing something and I am not going to start worrying just yet. Just a thought

Anyway, very interesting.

-Jim

15

Yes, they really are like banks now. Aside from utlizing their clients cash for higher yield, they have other revenue streams that are typical to large banks. They offer a FDIC Insured Checking account with online bill pay and mobile deposits through their app. An official Schwab American Express credit card with cash back rewards. A partnership with Quicken Loans so that you can apply for a home mortgage through the Schwab Portal. I would be surprised if Fidelity, TD and all the big brokerages aren’t the same.

16

E*TRADE Announces $0 Base Rate Commissions for Online Stock, ETF, and Options Trades effective Oct-7.

17

Here is a link from Bloomberg that expands on Cary’s post: [url=https://www.bloomberg.com/opinion/articles/2019-10-03/schwab-commission-free-trading-means-disruption-for-advisers]https://www.bloomberg.com/opinion/articles/2019-10-03/schwab-commission-free-trading-means-disruption-for-advisers[/url]

One reason for adding this is that the article talks about the relationship between discount brokers and advisors.

Would P123 be an advisor as defined by the authors of the article?

If so, looks like Schwab would not mind if the average retail investor bypassed P123 and went directly to Schwab.

On a deeper level it is like game (in the mathematical sense): a cooperation/competition game. Here is an example of a similar and real game. Physician needs the hospital for the operating room (unless the surgeon builds its own ambulatory surgery center) and to admit sick patients. The hospital needs the physicians to refer patients to their hospital (and not another hospital in the community).

In a move similar to Schwab’s decision (as per the article), the hospitals have decided to hire their own physicians. Actually most cooperation with the non-employed physicians is illegal (anti-kickback laws) but that is another story.

Anyway, Schwab would like to bypass P123 and move any advisors people may need into Schwab, if the article is to be believed.

On the other hand. Tradier does not have a lot of in-house advisors. IB, not so much either I think. So, they probably still want to cooperate with P123.

IB is hit much harder than Schwab by the loss of commissions, I think. Tradier, is built on the idea of no commissions, so it may be well suited to this environment.

“Fascinating, Jim. Any useful information in this long post?”

Yea. IB needs P123 more than we could have realized: their advisor base is being threatened. P123 should try to negotiate the reduced high volume discount on commissions (and the market maker rebates) with IB. P123 probably does provide the volume required (aggregated) for the discount. It would be in their interest, I think, as the they still make money on the trades and the increased flow would more than make up for the discount in the long run.

-Jim

18

I tried with IB… They think they are smarter than all , and get offended if told their platform is hard to use.

19

A question by Jim: [quote]
Would P123 be an advisor as defined by the authors of the article?
[/quote]
The article suggests advisors will be courted/bought by the brokers, to capture the advisory fees. A parallel desire by brokers would be to attract more investors by adding tools that provide capabilities they do not currently market. TD Ameritrade, for one, focuses heavily on technical traders. They and other brokers lack the kind of analytical tools provided by Portfolio123.

I can’t help but think that Portfolio123’s analytical tools and techniques would add value for brokers as they search for new sources of income, thereby making Portfolio123 an asset to pursue. I hope that this company can remain independent and grow, for my own selfish reasons!

20

To further expand on Cary’s post: Schwab really does want to use your money.

From Schwab’s site:

"Schwab has eliminated sweep money market funds as a cash feature for most new and existing accounts."

Fidelity (for now) has the option of an FDIC insured cash sweep or SPAXX which is a “Fidelity Government Money Market.” The seven day yield was 1.62% on SPAXX.

BTW, SIPC insures your account for $500,000 if the brokerage goes broke. SIPC would not insure SPAXX if the government bonds became worthless (not likely) but there is the FDIC insured option for worriers—e.g., those who become concerned when the impeachment civil war begins and the red states issue their own currency;-)

Free commissions could cost you if you keep a lot of cash in your account assuming you are not like Marco (and are more like me) and do not put your cash into MINT each day after your trading of stocks is done—or you cannot buy MINT commission free.

-Jim

21

I think this was my point. All else is not equal. At least you knew what you were paying before. Now, it’s some convoluted game.

Besides, getting your orders routed to a high-frequency firm for your own “high-frequency” trades is a pretty bad strategy. Then, one doesn’t get paid interest on cash? It’s more complicated this way and you must measure more carefully to see if you’re better off.

22

Looks like Tradestation joined the fray - with some conditions.

https://www.tradestation.com/promo/tsgo/

23

We seem to be talking about Schwab a lot in this post so keeping it limited (to Schwab):

Payments for order flow disclosures: https://www.schwab.com/public/schwab/nn/legal_compliance/important_notices/order_routing.html

Order Price improvement: https://www.schwab.com/public/schwab/active_trader/trading_tools/execution_quality/retail_execution_quality_statistics

Schwab has stopped disclosing the price improvement for stocks other than the SP500.

-Jim

24

Relevant:

Source - Interactive Brokers 2018 Annual Report.

Comments:

Obviously, this letter needs to be taken with a grain of salt as he is biased in favor of IB.

25

Chaim,

I think the letter needs to be taken at face value. He just told you what happens at IB.

By that I mean, if you direct your order (with IB) to “Midprice Orders” you will be directed to some dark pool somewhere.

Otherwise, see rest of letter for how your order is routed. So, Midprice is good right? Well, your order may not be excuted quickly because there is no routing elsewhere when you select this option. You just have to hope the dark pool that they direct you to has enough orders on the other side to fill your order.

Ideally you would have a smart broker that does not need to be told you like Midprice and would also know that if there are not enough orders on the other side in the dark pool the order should be routed to other exchanges. Ideally, the smart broker would check more than one dark pool. This is not what you get at IB.

Of course, if you sit at monitor all day or script your own algo you can get smart routing (without payment for routing) through IB. Still, you ultimately know nothing about the dark pool he has chosen—including whether he takes payment for routing to that dark pool.

Thomas Peterffy has just told you what happens to your order at IB. Biased or not, it is not that good for IB.

-Jim

26

Chipper , thanks for sharing the letter . Peterffy is obviously subtly marketing his midpoint order types which are only available on IBKR Pro (not sure if he’s advocating for “pegged to midpoint” or simply midpoint). Nonetheless his insights are welcome and validate my general dislike for market orders or pegged orders. I suppose market orders are ok for big liquid names, but I still don’t like using them.

He also validates my belief that investors that follow strategies, and are not day-trading, should always use Limit orders and a little patience. What’s the rush to get filled immediately? Let the market volatility work for you instead of against you by chasing it! We are wrapping up some tweaks to our Automatic Limit Order system. It’s really powerful and easy to use. You can send 50 limit orders set to a “patient price” with a few clicks. Then you can change the ones that did not fill with more aggressive limits, or midpoint, just as easily and without ever typing a limit order by hand. Fills take longer of course, but eventually come around.

Currently the Automatic Limit Orders will only work well on Tradier, but we will soon allow you to manage accounts at other brokers. We’ll officially announce and demo it very soon. Stay tuned.

27

Marco,
While you are in there making changes, please think about doing a funari order.
Funari is a limit order that gets converted to a MOC order at the end of the day.

28

We’re trying to create a uniform interface to different brokers. Tradier does not have MOC . However most do I think, so we will support using it.

In any case we are planning our own customizable order management system based on limit orders. Design goals are ease of use and hands off (could be entered the day before for example). You will be able to rebalance an entire portfolio with custom order types like :

  1. start with a patient limit based on current price at 10AM
  2. after 2 hours switch to a limit price based on the current midpoint
  3. switch to market before the close (or MOC if available).
29

Marco,
This will work for me.
The key is to be “hands off” for the day.
I can set it up before the market opens, but I can’t reliably tend to it during the day.

30

IMHO, that is awesome for too many reasons to enumerate.

31

Fidelity just joined the party; https://www.fidelity.com/why-fidelity/pricing-fees