The promise of commission-free ETFs has steered many index investors toward independent brokerages such as Questrade and Virtual Brokers. These deep discounters have a lot to offer, but before you sign on, make sure you understand the details of their pricing.
Orders at these brokerages may be subject to fees that originate with the exchanges and networks that match buyers and sellers. This includes the big boys such as the Toronto and New York Stock Exchanges, as well as a host of lesser-known electronic communication networks (ECNs) and alternative trading systems (ATSs). Though it’s not technically accurate, you’ll often hear all these costs lumped together as “ECN fees.”
ECN fees are applied on a per-share basis. They vary slightly depending on the brokerage and the specific exchange, but they’re always fractions of a cent. At Questrade, for example, the cost is $0.0035 on Canadian stocks and ETFs, while Virtual Brokers charges $0.0039.
It’s a very small cost—less than $2 on an order of 500 shares—but ECN fees are irritating because it’s hard to understand when and why they apply. So let’s dig a little deeper.
ECN fees do not apply on every trade: they are only charged when a buy or sell order “removes liquidity.” What does that mean? An order that removes liquidity is one that is likely to be filled immediately. That includes all market orders, where the investor simply accepts the current price without specifying a minimum or maximum. It also includes marketable limit orders, which I described in my previous post. A marketable limit order specifies a price that is either above the ask (when buying) or below the bid (when selling). Like a market order, this type of limit order will usually be filled right away.
Now consider a limit order with a price that is lower than the ask (when buying) or higher than the bid (when selling): this is called a nonmarketable limit order, since it is not likely to be filled immediately. It will sit on the exchange’s order book waiting for someone to agree to the price being offered. Therefore, it “adds liquidity” to the market.
In most cases, whenever a trade is filled, one party adds liquidity and the other removes it. Only the latter will be charged ECN fees.
To help clarify this idea, let’s revisit the example I used in my previous post. Suppose three investors—Mark, Cheryl and Barney—want to buy 500 shares of the Vanguard Canadian Aggregate Bond (VAB). Their quote looks like this:
Our three investors place their buy orders as follows:
- Mark places a market order for 500 shares.
- Cheryl places a limit order for 500 shares at $25.56, two cents above the ask price.
- Barney places a limit order for 500 shares at $25.52, two cents below the ask price.
In this example, both Mark and Cheryl are likely to see their orders filled immediately, so they are removing liquidity. Both would incur ECN fees of $1.75 (that’s 500 shares × $0.0035). Barney’s order will probably not be filled right away, since it’s a nonmarketable limit order: because he is adding liquidity, he won’t incur ECN fees.
Now that’s odd
There is another way you can incur ECN fees, even if you use a nonmarketable limit order: by placing orders that are not multiples of 100 shares.
In trader jargon, blocks of 100 shares are called board lots, while blocks of fewer than 100 shares are called odd lots. If you place an order for 420 shares, for example, it’s called a mixed lot, consisting of four board lots plus one odd lot of 20.
According to Questrade’s forums, an odd lot can remove liquidity even if your limit price is above the bid or below the ask. Moreover, a mixed lot may get broken into two separate orders, with the board lots and odd lot filled separately. If this happens, ECN fees may apply to the odd lot, though not the entire order.
This isn’t a big deal if you’re buying 1,005 shares. But many ETF investors will make frequent small trades, since they’re not paying any commissions. And if you’re routinely buying 70 or 80 shares, then all your orders will be odd lots and they may incur ECN fees no matter where you set your limit price.
Penny wise, pound foolish
So what’s the advice for investors using brokerages that charge ECN fees? This is a popular question on web forums, and the answer usually goes like this: “Make sure you always use limit orders that add liquidity, and only trade in board lots.”
But while that will help you avoid ECN fees, I think it’s bad advice. First, it’s not realistic to always trade in board lots, which can easily be multiples of $2,000 to $3,000. More important, using nonmarketable limit orders is poor practice that can easily lead to throwing away dollars to save pennies.
Let’s return to our example, where Barney uses a lowball order to sidestep ECN fees. Imagine his original buy order at $25.52 goes unfilled, and within an hour bond prices start to tick up. Soon the ask price of VAB is $25.56, and then $25.58. When the markets close at 4 pm, Barney’s order expires. The next day, with more turmoil in the stock market, bond prices are higher again and the ETF is trading at $25.60 by mid-morning. Now Barney places another nonmarketable limit order to buy 500 shares at $25.58, and this time he gets lucky: the price falls briefly, his order eventually gets filled, and he saves $1.75 in ECN fees.
But look what happened: Barney’s cleverness means he wound up paying $25.58 for a fund he could have bought the day before for $25.54 if he had simply placed a marketable limit order. That means he paid an opportunity cost of four cents per share, or $20, to save that $1.75.
The lesson here should be clear: if your brokerage offers commission-free ETFs, just accept the ECN fees as a reasonable trade-off. Use marketable limit orders for all your trades, even if it costs you a couple of bucks. It makes no sense to risk seeing your order go unfilled to save a fraction of a penny per share. Costs are always important in investing, but don’t forget that opportunity costs can be much higher than commissions and fees.
Just to be clear: Virtual Brokers sometimes does not charge ECN fees — it depends on the commission structure you’ve chosen. People who have selected “The Penny” or their “Free ETF Investment” commission structures never see ECN fees. These are actually the two which are probably of interest to casual traders.
On the other hand, Interactive Brokers, which may not be suitable for most DIY investors, will actually pass on rebates for adding liquidity (and also pass on the fees for removing liquidity). Other brokerages keep the rebates for themselves.
Excellent article, Dan.
@Tyler: Thanks for the info. Clearly the policies are different at every brokerage, so if other readers have experiences to share, please do so.
@Russ: Thanks, much appreciated. It was surprisingly hard to find clear and reliable info on this topic.
ECN fees are brought up in online forums way too often. For an ETF trading at $20, a $20000 order will have ETF fees of $3.50. Unless you trade penny stocks, its not worth the time spent worrying about it.
@Matt: I tend to agree. Investors should understand how and why they are charged, and they should always be cost-conscious, but I don’t think they should be straying from a disciplined strategy just to avoid them. It reminds me of people who drive out of their way to save a penny per litre on gas. :)
I never knew this, thanx, really enjoyed this article. I’m with Qtrade and with their newly lowered fees I wondered why I was always getting charged a bit more and always a slightly different amount.
You mentioned that mid-term Canadian bond ETF’s are doing very well this year. I understand that it’s not ideal to have bonds in a taxable account, but I’m wondering if it would be better than using GIC’s, at this point, if you really need to purchase a lot of Fixed Income, but can’t use an RRSP. I am in the lowest tax bracket.
Dan – your last couple of ETF articles have been super. Thanks for shedding light on issues for some beginner+ investors.
I always thought buying non-board lots was a bad idea. My online broker (TD Waterhouse) posts a warning when you do this. Are you saying there’s no pricing penalty when you buy or sell odd lots?
Agree with Russ. Excellent article, Dan.
ECN fees are very confusing. This has shed a lot of light on the topic. Thank you.
@David: With large, frequently traded ETFs it’s not a problem in my experience. It might be more of an issue with less liquid ETFs.
That said, it’s not that uncommon to see mixed lots filled at slightly different prices. For example, you might place an order to buy 460 shares with an ask of $20, and find you get 400 for $20 and the other 60 at $20.01. At that point the question becomes, how concerned are you about paying an extra penny for less than 100 shares?
It would be ideal to trade only board lots, I suppose, but it’s just not realistic for most retail investors.
I use Interactive Brokers and have never been charged an ECN fee or a fee for odd lots. Bought 223 shares of UPRO yesterday total commissions $1.00. And IB is now a Canadian online broker. Just FYI.
Although I can appreciate that your hypothetical buyer buys at a higher price the following day in a rising market, the reverse situation is also true: if the price falls, the lower limit price will capture the same shares at a lower price. The mathematical expectation is essentially zero for setting your limit order one cent below the ask price if we assume that the price of the stock moves randomly.
Thank you! The first time I got hit with these fees, I asked Questrade, and they said something about “removing liquidity” that didn’t make any sense. I stopped worrying about it, because the fees were pretty minimal, but it’s nice to know what they meant.
@SNB: You’re right, of course. But if you are an investor executing a disciplined strategy, why would you place an order that has a 50% chance of being filled?
@SNB,@DAN. not to be too technical, i would think setting one cents below would have mathematically less than 50% to be filled, since it doesn’t if price does not move, or if there is more outstanding orders at the set price than what gets sold at the strike price. so in the end, it would likely be a small opportunity loss. pennies i know, but so is what is trying to be avoid by doing so.
I’ve always used Barney’s strategy, but not because I’m trying to score a bargain. I place the limit order a penny or two in my advantage so that I’m protected from the second-to-second volatility in the prices. Most of the ETFs I purchase tend to have their bid or ask price fluctuate by at least 1 cent several times a minute, in both up and down directions. It doesn’t just gradually increase or decrease. Because of this, over the course of 1 or 2 minutes, I believe Barney’s limit order placed at $25.52 actually has a better than 50% chance of being filled. Sure the price could surge up a few pennies and then the fluctuation might be around $25.55 – $25.59 and then if the price continues rising, Barney would be missing out. But he’s keeping an eye on things, and upon noticing that the ask price has started bouncing around a range higher than his order, he cancels his original order and places a new one, again just 1 or 2 pennies below ask. Mark and Cheryl are both subject to buying in at the “peak” of these fluctuations.
I’ve done this with all my orders and have always had them filled in 3 or less re-tries. Very rarely do I end up paying higher than I would have if I had just placed a market order. I agree there is some element of gambling, and it’s even a bit like trading penny stocks, but the fluctuations are always there and I’m certain you’ve got a better than 50% chance of being able to take advantage of it – if you keep updating your limit order to be within a penny or two of the ask price.
Thanks for this. I’ve been a bit confused about the different fees for a while but haven’t got too worried about them as they are typically quite small. I’m with virtual brokers and use their “Free ETF” trading format. I mainly only buy and/or sell ETFs (although I did experiment a bit with some different stocks…naughty couch potato!). Anyway, I’ve always wondered how they are making money off of me if I only buy/sell ETFs and never get changed a fee for the transactions. Is there something I’m missing? Thanks!
@Rod-knee: I think it’s fair to say that discount brokerages lose money on disciplined ETF investors, since they earn their profits primarily on trading commissions and interest from cash balances. The fact is there are very few investors like this. Most people trade too much, plain and simple.
Dan, thanks for explaining the ECN fees.
Using Questrade, I just bought about $2,000 of Vanguard’s US Total Market Index ETF — ticker symbol VUN.TO.
The ECN fees were only 19 cents.
I work for a Canadian bank. We have a highly-rated, self-directed trading platform.
But even with my employee discount, Questrade still offers lower trading costs on ETFs.
Price isn’t everything, but it’s important.
I use Virtual Brokers and purchase ETF’s bi-weekly under the “Free ETF Investment” structure. This is commission and ECN fee free (to purchase). You state most people trade too much, plain and simple. Does that statement apply only when using discount brokers that charge purchase commissions and ECN fees? Or also to people who take advantage of commission/fee-free ETF purchases? Thanks!
@Nic: If you’re simply investing some new cash every month, I wouldn’t criticize that as “trading too much.” That’s a good thing, as long you’re not paying commissions on every trade.
Thanks Dan! Love the site.
What happens when you buy 1 share, which its ECN fee is less than 1 cent, does it get charged?
I stumbled on this subject when trying to buy 1.3m+ shares for $0.01 which is the ask. ECN fees over $1000. Difficult to understand the rationale.
I opened an account with Questrade due to the low advertised commission. Placed a couple of market order stock trades and being charged for ecn fees. 1000 shares cost around $13.5 commission, so about $7 more than Investorline round trip, imagine if I have gone with the regular quantity of 5000. Today I just bought 10,000 shares on Investorline account with $9.99 x 2 commission, 2 separate stocks. With these fees, it’s no brainer I am sticking with Investorline.
I googled ECN fees and your name came up. A trusted source on all investor topics. ThanksDan
Hi Dan, I’ve always taken your advice to be disciplined, and to buy and sell mechanically. I didn’t worry too much about ECN fees – as you’ve stated, they’re typically a small amount. However, a recent experience with DLR made we wonder if your advice to just accept ECN fees still holds true at larger volumes.
I’d purchased DLR.TO, journalled it over to DLR.U.TO and sold it. Shockingly, because of the large number of shares (3,400), I ended up paying $11.90 USD just in ECN fees – on top of the $9.95 USD commission for Questrade. This single Norbert’s Gambit cost me about $30 CAD!
In this case, there was no way around the ECN fees; DLR.U.TO trades at the same price all the time – there is no way to place an order outside the bid-ask spreads if you’d ever like your order to be filled!
That said, what are your thoughts? Is this just an unavoidable cost?
@Chrissy: Norbert’s gambit is cheap, but it’s not free. If you traded 3,400 of DLR, that’s about a $44,000 CAD transaction. The $30 in ECN fees and commissions represents a cost of less than 0.07%. We generally assume you lose another 0.20% or so on the bid-ask spread, so let’s say about 0.27% all-in. Had you accepted Questrade’s normal forex spread you likely would have paid 2%, or about ($880). I’d say you made out extremely well.
Thanks for the reply Dan. I did make out well, and moving forward, I’ll just plan for this as part of the cost of investing. I appreciate your always level-headed responses to such issues.
Excellent detail as usual Dan. Thank you for writing this up. A great resource for anybody asking about this.
Thanks for this article, it finally makes sense to me. Where ECN fees can become significant is penny stocks – for example, buying a large amount of shares, say 20,000, will have over $16 in ECN fees, besides any other trading fees!
One way to avoid ECN fees,is buying 1 share of stock per day. This works for people who trickles the funding.
i placed an order on questrade which was a limit order below the asking price for 1000 shares. They still charge the ECN fee. When i asked questrade support, they actually sent me a copy of your examples. When i explained that my example was the Barney one. Their response was that that the example says typically not charged as a result it could be charged. It seems they could not give a better explanation. As a result their overall fees are higher than the other’s including RBC, TD and BMO
Thank you for this article!!