ELI5: ECN Fees

You're new to investing, have done your homework and is ready to get started. You find a discount brokerage offering commission-free ETF purchases. Perfect! You'll save a ton on fees. You enter in your first order and to your dismay, a fee! ECN? What is this? I thought there were no fees?

Commission-Free Doesn't Mean Free?

There's a misconception that commission-free trading equals to no-fee trading. A commission is the cost of facilitating and executing a trade. Commission-free still leaves room for other charges, such as foreign exchange fees and the lesser-known ECN fees.

ECN Fee? 

ECN stands for Electronic Communication Network. ECNs are intermediaries that match brokers to stock exchanges. ECNs charge on a per-share basis for their services, typically fractions of a penny. Some brokers pass these fees down to their clients, others just absorb them.

When Do They Apply?

ECN fees only apply to trades that "removes liquidity". A trade that removes liquidity are those that fill immediately. Such as market orders or a marketable limit orders. 

A trade that adds liquidity is one that wouldn't fill right away, such as a limit sell order above the current ask price or limit buy order below the current bid price.

For example, if SPY has an ask price of $250 

- A market order or limit buy order of $250 would be filled immediately, taking it off of the exchange's order book, thus removing liquidity

- A limit buy order of $245 would not be filled immediately, sitting on the exchange's order book until a willing seller arrives, thus adding liquidity.

But Wait, There's More

Orders in blocks of 100 shares are considered broad lots. A block of 100 shares is the standard trading unit for exchanges and this standardization can increase liquidity. Orders less than 100 shares are known as odd lots, these can remove liquidity. If you put in an order for 105 shares, this is known as a mixed lot. These get split into two orders, one broad (100) and one odd (5). Only the odd portion will remove liquidity.

So even if you put in a non-marketable limit order, you could still be removing liquidity by having odd lots.

Should I Avoid Them?

ECN fees are annoying, especially when you don't expect them. However, it's simply not worth the trouble trying to avoid them. By using orders that add liquidity, you face the bigger cost of not having your order filled. It's also not practical to trade only in broad lots. If you really want to avoid ECN fees, try finding a broker that doesn't pass them down to you. If such a broker doesn't exist, or exists but has other pitfalls, remember the fee is small. Think long term, ECN fees won't matter in the big picture.