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Glossary
Commission (trading commissions)
Definition
Commissions are fees brokers charge for the services they provide by acting as the gateway between securities and traders. Traders are charged commissions by full-service brokerages for handling the sale or acquisition of financial instruments on the traders’ behalf.
A closer look at commission and other trading fees
Why do brokers charge commissions or fees in general?
Broker commissions are packaged as a reward to the broker. They cover the time and costs that brokers incur in providing their trading services to clients. It’s not uncommon for trading brokerages to use commissions and other charges to put towards the salaries of their own staff and any other ongoing costs such as licenses for trading platforms.If brokers opted not to charge commissions to traders, they would have to design an alternative way of earning money from their clients. If not, they wouldn’t generate sufficient revenue to operate their brokerage profitably.
A full-service brokerage, which handles all aspects of the buying and selling of financial instruments for clients, makes a large percentage of its annual income from commissions on its clients’ trades.
Online brokerages that are deemed “execution only” will have the flexibility to charge cheaper commissions to their clients. That’s because they’re not duty-bound to provide investment advice or recommend trades on behalf of their clients. In fact, it’s not uncommon for some brokers to offer commission-free trading, with no commissions charged per share or per trade. The obvious benefit of a commission-free trade is that more of your own money can be spent on the trade rather than on fees.
Trading fees are commonly charged in one of two ways: commission-based or flat-rate fees. For brokers who use commission-based fees, these can be charged either per share or per trade. Each of these fee setups can have different implications for traders.
Trading commission vs flat-rate fees
Flat-rate fee-based trading is very different from commission-based trading. Flat-rate fees are largely offered by financial advisors or brokers that charge a fee for handling client funds and making crucial decisions for clients’ portfolios. Flat-rate trading fees are usually displayed as a percentage of a client’s assets under management (AUM) or as a fixed dollar amount.
Commission-based fees are usually charged per trade or per share by discount brokers that only execute market orders on behalf of their clients. Think of it as a thank you for the broker’s attempt to place your trades at the right time and the right price, so you don’t have to.
Commission per share and commission per trade: what’s the difference?
There are different models that brokerages adopt when charging commissions to their trading clients. For buying and selling stocks in particular, brokers will usually charge commission per share or per trade. Commission per trade means all traders are charged the same commission for each trade, for any number of shares or up to a certain maximum number of shares. Commission per share means traders pay a percentage per share, so each trader’s commission fee varies based on the number of shares they are trading at the time.
Commission per trade typically benefits less active traders that trade large position sizes, as they receive the same prices as traders with only a few shares. Commission per share can be best for active day traders that trade with smaller position sizes—just be sure to check the broker’s fee structure and whether higher trade volumes receive lower pricing.
Why commission and spread are important for traders to understand
Commission is important to anyone that trades financial instruments through a broker. Commission is something that you must factor into your costs of trading. It’s important to differentiate commission from the “spread” offered on your selected asset(s) by your broker.
The spread is the gap between the ask (buy) price and the bid (sell) price. The bigger the gap, the more the position will need to move to become profitable. This is different from commission, as the spread is something that’s not determined by your broker. The spread is defined by the exchange’s order flow at the time you wish to place a trade. Commission is openly charged by brokers for use of their services.
It's not uncommon for some brokers to tinker with the spread available if they prefer to offer commission-free trading to their clients. If they choose to go down the commission-free route, it’s more likely that the spread between the bid price and the ask price will be greater than for brokers that are charging commissions.