How market makers make money from your trade
If the trade is free, the spread is the fee, and it is invisible by design.
Understand what actually happens in the two seconds after you press buy.
How market makers make money from your trade works, in one picture
The same argument as the text, as a chain. Each step is what makes the next one possible.
The fee you never see
You buy at the ask and sell at the bid, so you are down the spread the instant you trade. In an illiquid stock it dwarfs any commission you thought you were avoiding.
- 1
There are two prices, always
The bid is the most a buyer will pay. The ask is the least a seller will accept. You buy at the ask and sell at the bid, so you are down the difference the instant you trade. That difference is the market maker's revenue.
- 2
The market maker takes the other side of everything
Their job is to always quote both prices, so that you can always trade. They are compensated for that service, and for the risk of holding inventory, by the spread. This is a real service and it is worth paying for.
- 3
Payment for order flow moves the fee somewhere you cannot see
Some brokers sell your order to a market maker rather than sending it to an exchange. That is what pays for 'commission-free' trading. Whether you get a worse price as a result is genuinely contested, but you are certainly not the customer in that arrangement.
In liquid mega-caps the spread is trivial. In a thinly traded small cap it can be several percent, which dwarfs any commission you were avoiding.
- 4
Which is why the limit order exists
A market order says 'buy at whatever the price is'. A limit order says 'buy, but not above this'. The first guarantees execution, the second guarantees price. In anything illiquid, the second is the adult choice.
You never place a market order in an illiquid stock again.
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If the trade is free, the spread is the fee, and it is invisible by design.
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