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Trading costs can be divided into explicit costs and implicit costs. The explicit cost is the commission charged by the stock broker. The implicit costs are the price impact of the trade, and the opportunity costs when a limit order is not filled (e.g. due to delays or bad order routing). The implicit costs are difficult for retail investors to measure, although I would assume that the price impact of a small trade is negligible for liquid stocks.

The explicit transaction cost is zero when using a commission-free stock brokerage, but what about the implicit costs? Is there any evidence to suggest that zero commission stock brokers are cheaper overall for retail investors, when compared to those stock brokers that charge commissions?

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    Is there any evidence to suggest that brokers which do charge commissions don't also happily pocket the hidden profits for order routing and lending (which you have called "implicit costs")?
    – Ben Voigt
    Aug 3, 2021 at 22:17
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    If I remember correctly I paid $4.95 before Schwab went to zero and $7.99 before Scottrade went to zero, do you really think, at retail trading volumes, the mythically increased bid/ask spread captures $4.95 on every trade on average? Schwab, as an example, makes its money primarily from net interest margin, not commissions, not payment for order flow. That means for Schwab it is more advantageous to have more customers with more idle cash than to charge $4.95 per trade.
    – quid
    Aug 3, 2021 at 22:19
  • The answer to this may depend on the region as well. In Europe, MiFID 2 requires that alternative exchanges do not disadvantage the investor compared to a reference exchange (e.g. XETRA for Germany). So the broker may route the order to the exchange that pays the largest kickback but the investor will still get a competitive price during regular trading hours
    – Manziel
    Aug 4, 2021 at 6:45
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    There's a lot to unpack in these two articles but worth a read: Article 1 and Article 2. Aug 5, 2021 at 15:23
  • Of course, if you're investing in low-fee mutual funds you may have the option of going directly to their in-house broker, which avoids the question of transaction fees entirely.
    – keshlam
    Dec 27, 2022 at 8:08

1 Answer 1

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I agree with what @quid wrote in his comment:

If I remember correctly I paid $4.95 before Schwab went to zero and $7.99 before Scottrade went to zero, do you really think, at retail trading volumes, the mythically increased bid/ask spread captures $4.95 on every trade on average? Schwab, as an example, makes its money primarily from net interest margin, not commissions, not payment for order flow. That means for Schwab it is more advantageous to have more customers with more idle cash than to charge $4.95 per trade.

However, I don't think that it's that simple. I have often read that trades routed for payment for order flow can end up on less liquid exchanges and therefore the fills can be inferior and/or trades fills can be missed. If that's true, I doubt that there is any way for retail to quantify what could have been since it would involve knowing what was available on other exchanges at the same time.

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