It sounds like this“The gap between bid and ask is a hidden fee that my broker takes.”
Thinking the gap is a fee the broker keeps
Why it feels right
A cost you didn't see agreed to feels like a trick. Brokers advertise zero commission, yet buying and selling still costs something, so people reasonably suspect that the missing fee is hidden somewhere, and the spread looks like the best place to hide it.
Why it’s wrong
The gap exists on the exchange even if there are no brokers. It pays whoever stands on the other side of your trade, usually a market maker, for being ready to buy or sell at any moment and for the risk of holding shares that may fall.
A worked example
The spread isn't set by your broker. It comes from the orders resting on the market. Anyone can post a bid or ask; the biggest posters are market makers, firms that quote both a price to buy and a price to sell, all day, for a stock.
As a market maker, buying at 99.90 and selling at 100.10 earns 20 cents on each share that goes both ways. In return, they stand ready when you want to trade, and they take the risk: if they have just bought shares at 99.90 and bad news arrives, they can lose far more than the 20 cents.
There are real costs in the system besides the spread, such as commissions, and some brokers are paid by market makers for sending them orders, which is a fair thing to ask about. But the spread itself is the price of having someone to trade with immediately. Where many people compete to quote, it shrinks to a cent. Where few do, it is wide.
How to catch yourself
- You say the spread is 'what the broker makes'.
- You think zero-commission trading is free.
- You can't say who is on the other side of your trade.
What to hold instead
The spread is paid to whoever stands on the other side of your trade, usually a market maker, for being ready at all times and for the risk of holding shares. It exists on the exchange itself and shrinks where many compete.
Where you’ll meet it
- Choosing between a zero-commission and a paid broker.
- Understanding why some stocks cost more to trade.
- Reading about market makers in the news.
Questions people ask
- Who earns the bid-ask spread?
- Whoever stands on the other side of the trade, typically a market maker who quotes both a buy and a sell price. They earn it for providing instant trading and for risking losses on the shares they hold.
- Is a zero-commission trade really free?
- There is no commission, but the spread is still a cost, and your broker may be paid for routing your order. You still buy at the ask and sell at the bid.