A study performed by professors from the University of California, Irvine found that there were vast discrepancies in the costs of using different online brokerages offering commission-free trading. Bloomberg’s Eva Szalay reports:
Last year, five US professors opened two brokerage accounts and placed identical orders to test an algorithm. The next day, one was down by $150. The other was up $12.
They discovered it wasn’t a one-time anomaly.
Over more than five months, the academics used their own funds to execute 85,000 trades in 128 different stocks and made what they consider an important discovery: They were getting significantly different prices to buy and sell shares, depending on which brokerage handled the trade. Extrapolating from the results, they estimate it costs small-time US investors as much as $34 billion a year, said Christopher Schwarz, the finance professor at the University of California, Irvine who wrote the study along with four colleagues.
The paper indicates there are hidden costs to the day trading that’s proliferated along with no-fee brokerage accounts. That’s because even though trades are funneled through a handful of wholesale market makers, including Citadel Securities and Virtu Financial Inc., the pricing can vary, according to the paper. And those small discrepancies can have a large impact overall.
“Brokers are getting very different execution quality at the same market center,” Schwarz said in an interview. “Based on the data, market centers have an incredible power over brokers.”
The overall cost figure is an estimate of what investors would save if their orders were executed by the best performing of the five brokers in the study instead of the fourth best. It estimates that some $20 billion of execution costs would be saved if trading costs were cut by 0.10%.
In their experiment, the professors placed their trades simultaneously with five different brokers, all of which offered zero commission trading. Only some of them had payment-for-order-flow deals with market makers, an arrangement that allows large trading firms to buy orders from retail intermediaries. Such arrangements have drawn scrutiny since the start of the pademic’s meme-stock frenzy because the interests of brokers and markers can be aligned, potentially at the cost of investors. But the study found it had little impact.
There was, however, a “very large variation” in prices achieved from buying and selling stocks at different brokers, with the execution of some trades costing 10 times more — as measured by the basis-point spread that was charged — when made through one intermediary than with another.
Out of the six market makers that handled the orders in the experiment, more than 60% of all orders eventually went to Citadel Securities and Virtu. A spokesperson from Virtu declined to comment.
Read more here.