Commissions

Commissions are a fact of life and the cost of doing business. They

affect your true profit and must be considered when performing a

rate-of-return calculation. You must always remember to include

the commission. Not including commissions in your calculations

will give you a false picture of your rate of return and true profit

potential. Unmanaged losses and commissions can make the difference

between being a profitable trader and a losing trader. In many cases, individuals will try to cut the cost of their trading by looking

for the cheapest commission around. Don't ever make the assumption

that cheap is good. This is a lesson that the public never seems

to learn and a professional understands all too well. It is especially

true when it comes to commissions. I know companies that advertise

commissions as low as $7 to $12. In fact, there are companies

that will offer commission-free transactions. Always remember that

you get what you pay for, and sometimes you get more than you bargained

for. Let me explain how that $7 to $12 commission could cost

you $512. In our example, you are buying a stock over the Internet

using brokerage company A. The bid is $30 and the ask $30 1/2. We are

buying 1,000 shares and the spread is $500. At the same time, someone

is selling the stock at the bid $30. What you don't know is that

the second the order arrives at Internet broker A, A sells the order

flow to firm B for $100 and charges you a $12 commission. Internet

broker A just made $112 on your order. Let's look at what just happened.

Because you were trading online over the Internet and not

using ECNs, you did not have an option of narrowing the spread, so

you did in fact lose money. You also had to pay a commission on the

trade. Large spreads benefit market makers and firms involved in

the practice of selling order flow. If you had been using an ECN, you

could have posted an offer to buy at $30 3/8 or 30 1/4 narrowing the

spread and saving the difference. Using ECNs, you might have been

able to buy on the bid, which is an opportunity that you will never

experience online. Look at the breakdown of numbers to see how

this transaction worked. Cheap commissions might be costing you

a fortune. If someone offers to sell you a diamond ring for a dime

and you buy it, you probably bought a diamond ring that isn't worth

a dime.

Internet Broker Firm A

$100.00 selling order flow

You Lose

$500.00 spread

12.00 commission_____ 12.00 commission

$+112.00 profit on transaction $-512.00 lost on transaction

trading strategies 43

Companies can offer commission-free trading on certain stocks

because the stocks usually have huge spreads of 3/8 to 1/2 point or

more. Most of the time they make markets in these stocks or sell

stock to you out of their inventory and make money on the spreads.

Who needs to charge a commission? By not charging a commission,

firms can always count on the something-for-nothing crowd to show

up and buy. In this case the word free cost you $500. I would be

happy to sell commission-free stock, because in a few years I would

be very rich and you would be broke. When you hear the words

commission-free transactions, someone is trying to sell you a 10 cent

diamond ring.

Commissions are a fact of life and the cost of doing business. They

affect your true profit and must be considered when performing a

rate-of-return calculation. You must always remember to include

the commission. Not including commissions in your calculations

will give you a false picture of your rate of return and true profit

potential. Unmanaged losses and commissions can make the difference

between being a profitable trader and a losing trader. In many cases, individuals will try to cut the cost of their trading by looking

for the cheapest commission around. Don't ever make the assumption

that cheap is good. This is a lesson that the public never seems

to learn and a professional understands all too well. It is especially

true when it comes to commissions. I know companies that advertise

commissions as low as $7 to $12. In fact, there are companies

that will offer commission-free transactions. Always remember that

you get what you pay for, and sometimes you get more than you bargained

for. Let me explain how that $7 to $12 commission could cost

you $512. In our example, you are buying a stock over the Internet

using brokerage company A. The bid is $30 and the ask $30 1/2. We are

buying 1,000 shares and the spread is $500. At the same time, someone

is selling the stock at the bid $30. What you don't know is that

the second the order arrives at Internet broker A, A sells the order

flow to firm B for $100 and charges you a $12 commission. Internet

broker A just made $112 on your order. Let's look at what just happened.

Because you were trading online over the Internet and not

using ECNs, you did not have an option of narrowing the spread, so

you did in fact lose money. You also had to pay a commission on the

trade. Large spreads benefit market makers and firms involved in

the practice of selling order flow. If you had been using an ECN, you

could have posted an offer to buy at $30 3/8 or 30 1/4 narrowing the

spread and saving the difference. Using ECNs, you might have been

able to buy on the bid, which is an opportunity that you will never

experience online. Look at the breakdown of numbers to see how

this transaction worked. Cheap commissions might be costing you

a fortune. If someone offers to sell you a diamond ring for a dime

and you buy it, you probably bought a diamond ring that isn't worth

a dime.

Internet Broker Firm A

$100.00 selling order flow

You Lose

$500.00 spread

12.00 commission_____ 12.00 commission

$+112.00 profit on transaction $-512.00 lost on transaction

trading strategies 43

Companies can offer commission-free trading on certain stocks

because the stocks usually have huge spreads of 3/8 to 1/2 point or

more. Most of the time they make markets in these stocks or sell

stock to you out of their inventory and make money on the spreads.

Who needs to charge a commission? By not charging a commission,

firms can always count on the something-for-nothing crowd to show

up and buy. In this case the word free cost you $500. I would be

happy to sell commission-free stock, because in a few years I would

be very rich and you would be broke. When you hear the words

commission-free transactions, someone is trying to sell you a 10 cent

diamond ring.