In the academics’ experiment, TD Ameritrade provided the best pricing, while Interactive Brokers trailed.
The authors attempted to execute the identical deals concurrently with several brokers over nearly six months, spending their money to purchase and sell stocks 85,000 times. They then measured the prices they received. According to Mr. Schwarz, the deals cost him and his colleagues roughly $23,000. Wall Street did not provide funds for the investigation.
Their research illuminated a murky area of stock trading. Although all significant online brokers provide execution-quality data on their websites, it is difficult for investors to determine whether they are truly getting the best bargain because the numbers are difficult to compare.
Brokerage executives appreciated the survey generally, but several, notably those that placed lower, questioned its conclusions.
According to Interactive Brokers CEO Milan Galik, “We have major doubts regarding the significance of their results, notably as they pertain to the comparative execution quality of Interactive Brokers.”
The report’s publication coincides with the Securities and Exchange Commission’s impending release of regulation changes designed to completely revamp how small investors’ trades are handled in the American stock market.
Brokers are required by law to look for the best execution for their clients. This means that when investors place market orders to buy or sell stocks at the current market price, their brokers try to beat the best price listed on open stock exchanges by a small amount.
For instance, if a stock is trading at $20 per share on the New York Stock Exchange, an investor trying to purchase it may wind up paying $19.9975 instead, receiving a fractional cent per share discount. Selling the stock might result in the investor receiving a fraction of a cent per share more than the best price listed on the NYSE.
The phrase “price improvement” refers to such a difference. The price improvement brokers receive for their clients serves as a benchmark for execution excellence.
According to the survey, they often received a significant price improvement on their orders, although it varied greatly amongst brokers. They saw an average price increase of around 8 cents each trade at TD Ameritrade. They received roughly 3 cents on the IBKR Pro platform from Interactive Brokers. Other brokers occupied a middle ground.
Even while these sums might appear insignificant, they build up, particularly for regular dealers. According to the authors, if all retail brokerages offered costs on par with TD Ameritrade, individual investors might save billions of dollars annually.
One of the study’s most unexpected findings, according to Mr. Schwarz, was that execution quality was not much impacted by payment for order flow, a controversial practice in which brokers are compensated for directing customer orders.
Through the Robinhood app, individual investors may trade equities.
Brokers send many orders for execution to electronic market makers like Citadel Securities or Virtu Financial Inc. These companies help investors with price improvements to some extent while also making money for themselves by purchasing equities at a small profit. Market makers frequently provide brokers a rebate, sometimes called payment for order flow, in exchange for managing transactions for their clients.
Gary Gensler, the chairman of the SEC, is one of the critics of this technique who claims that there is a trade-off between paying for order volume and execution quality. The thinking is that market makers can’t boost prices as much if they give brokers more rebates.
In contrast to these predictions, the study discovered that IBKR Pro, a platform that doesn’t accept money for order flow, had the poorest price improvement. Fidelity, which does not receive money for order flow for stock transactions, finished second behind TD Ameritrade.