In the third part of our series comparing Questrade’s $0.95 trade commission plan to Virtual Brokers’ $0.99 trade commission plan we focus on how order types can impact the total cost associated with either trading commission plan.  If you missed the beginning our series, you can read Part 1 here or Part 2 here.  If you’d like to read the full report, you can access it here.

No Shoe-In

Self-directed investors have been bombarded with commercials comparing buying stocks to online shoe shopping or a thrill-filled ride.  Without knowing about order types and routing, however, investors placing orders for stocks online can themselves sporting pair of uncomfortable fees – ECN & exchange fees to be exact.

One of the important distinctions between Questrade’s and Virtual Brokers’ lowest commission cost plans is whether or not electronic communications network (ECN) and/or exchange fees are added to the cost of a transaction.  Indeed this is true of many Canadian discount brokerage commission plans currently on the market.  Virtual Brokers’ $0.99/$9.99 commission plan commission doesn’t pass along any ECN or exchange fees whereas Questrade’s $0.95/$6.95 plan does.

What this means for investors using Questrade’s plan is that they have to be aware of what order types they’re using (e.g. limit vs market order) to ensure they do not incur added fees.  It should be noted that Questrade does offer clients the option of having certain US market orders routed across different networks without having ECN or exchange fees.

Convenience vs Price

ECN and exchange fees can be thought of as a kind of ‘convenience’ fee.  If a buyer wishes to get an order of stock at the current market price they must have that order filled by someone on the spot. This kind of order, known as a market order, allows the buyer to place getting the order filled immediately as a priority over execution price.  Conversely, a limit order is when an investor sets the price that he or she wants to either buy or sell a stock at. If there is a buyer or seller that is willing to accept the price, the transaction happens and if not, the order goes unfilled.  Thus, limit orders prioritize execution price over order fulfillment.

Stock exchanges and ECN’s like limit orders because they provide visible and ‘stable’ price levels that the marketplace can use to place their bids/asks around. Limit orders, therefore, improve “liquidity” as they create an identifiable pool of either buyers or sellers. To incentivize liquidity, stock exchanges and ECNs usually pass along cash credits to whoever places these types of orders.  When market orders are placed, they remove liquidity by reducing the identifiable pool of buyers or sellers and so exchanges and ECNs pass along a small charge to those who place these types of orders. From a tactical perspective, however, limit orders are the equivalent of ‘tipping your hand’ and as a result can be exploited by other market participants (such as market makers) looking to uncover areas of strong support or resistance.

Most Canadian discount brokerages, unfortunately, do not pass these credits given to them by exchanges or ECNs when their clients place limit orders however they will readily pass along the ECN and exchange fees. Thus, plans in which ECN fees are included (i.e. ‘flat pricing’) might be more on a commission basis for certain types of orders but actually end up being cheaper for others.

Some Strings Attached

In our comparison of Questrade and Virtual Brokers under a variety of trading scenarios, we found that ECN or exchange fees made a significant difference as to which plan was most cost-effective.   At extremely high trading activity levels, ECN fees can add hundreds of dollars a month in fees and can erase any advantage lower commission fees would have.

As the tweet from Questrade posted in the summer of 2009 suggests, traders should try to control their costs.  For example, a market order placed using Questrade’s $0.95/$6.95 plan for 869 shares (of a stock greater than $1) on a Canadian exchange, ends up costing as much as the a trade for 999 shares at Virtual Brokers:

$6.95 (commission) + 869 shares x $0.0035 per share (exchange fee) = $9.99 per trade

The equivalent transaction using Virtual Brokers $0.99/$9.99 plan would cost:

869 shares x $0.01 per share = $8.69 per trade

Thus, exchange fees make market orders of Canadian securities more expensive at Questrade than at Virtual Brokers.  If the order placed was a limit order, Questrade’s $6.95 cap would make it the cheaper option.

While Questrade offers a lower commission cost, it does so only with the subscription to a data plan and with a major string of ECN fees being tacked onto the cost of a trade.  If small, infrequent market orders are placed or if they’re not used at all, then Questrade’s plan might be compelling.

Virtual Brokers, on the other hand, has a different set of strings attached to its deal.  While they do offer $0.99 trading commissions without having to get a data plan, in order to qualify for the $9.99 cap investors need to be on the VB Webtrader platform and if they need a streaming data plan, an additional monthly charge is incurred.   One potential bonus with Virtual Brokers is that clients can switch between plans without penalty and thus can time their orders around the most advantageous plan structure to lower their costs.

The Bottom Line

Ultimately what our analysis found that investor behaviour – the decision to use limit orders or market orders, and what underpins that decision (fear, greed or necessity) determines the cost-effectiveness of each plan. Rather than focusing on low commission rates, self-directed investors have an incentive to focus on their trading behaviour and needs.  Knowing what your shoe size is before you go shopping is, after all, the better way to determine which pair will be the right fit.

In the final part of our special series we will take a look at additional interesting findings from our study from a total cost per trade perspective and provide some tips for investors to think about when considering these plans.