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Step 2. You fill out the order window to buy 100 XYZ with a market order, and you send the order electronically to your broker. |
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Step 3. Your broker receives your order as an e-mail and forwards your order to a trading firm. This is a needless step that wastes time. This trading firm is usually an active market marker that has entered into an agreement with your broker to provide the ''payment for order flow." What that means is that your broker has agreed to sell your order to the trading firm. |
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Step 4. The trading firm pays your broker for your order, usually one to three cents per share. |
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Step 5. The trading firm is now free to execute your order against the market when and where it chooses. This also takes additional time. To make up for the payment to your broker, the trading firm fills your buy order at a price slightly higher than the going market price, and your sell order at a slightly lower price. Today, this practice is legal according to the SEC. |
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Step 6. The trading firm receives confirmation of the execution. |
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Step 7. The trading firm now manually sends confirmation of the execution back to your broker. |
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Step 8. Finally, your broker manually sends confirmation of the execution back to you. |
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Step 9. You pay your broker a commission. The broker is being paid by both you and the trading firm. Is there a potential conflict of interest here? Which of these two is the broker's biggest customer? Certainly not you! |
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This process can take from 15 seconds to several minutes. The result is that, if you pay 1/4 of a point more than the best price at the time of order on 100 shares, you just paid an extra $25. On 1,000 shares, you would pay an extra $250! |
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As Bill Burnham, a venture capitalist at Softbank Capital Partners, recently wrote in the Financial Commentator: "Everybody's happy with $9.95 trades, but they're not looking at what their broker really costs them." How good does that low commission rate look now? |
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The direct access broker, on the other hand, provides professional-level tools to investors. It allows its clients to direct where their orders will be filled. |
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