When investors purchase shares of stock, the price paid includes two components: the price of the stock and the fee charged by the brokerage firm, called commission.
The price of a share of stock is determined in one of two ways. If the stock is newly issued, it can only be purchased on the primary market for a non-negotiable price set by the issuing entity. For example, a young company that decides to go public to raise equity capital may determine that $15 is a fair price for its shares since it is still in its early stages. It issues a predetermined number of shares at this set price for a limited amount of time. This is called an initial public offering (IPO). Any buying and selling of shares not related to an IPO takes place on the secondary market, where investor sentiment and market psychology determine the stock price.
The second component of a share purchase price is the broker commission. Individual investors may buy and sell stock through an online broker, while larger institutional investors may work with an investment bank. Either way, these middlemen only facilitate trades for a fee. Brokerage fees vary from broker to broker. Some charge a flat rate, or a nominal rate per share, while others may charge a percentage of the total trade value.
For example, assume an investor wants to purchase 100 shares of stock in company ABC. The company is not issuing an IPO, so he must purchase the shares on the secondary market for the current market price of $20 per share. The investor uses an online broker who charges 2% of the total trade value, with a minimum commission of $50. The total price of the shares alone is $20 * 100, or $2,000. The commission is $2,000 * 2%, or $40. Since the commission rate is lower than the minimum, the online broker charges the flat $50 brokerage fee, bringing the total price of the share purchase to $2,050.