What is payment for order flow?

Definition and Examples of Payment for Order Flow

Payment for order flow is the fees that securities brokers receive for executing trading orders from market makers and electronic communication networks. Securities brokers also receive direct payments from service providers, such as mutual fund companies and insurance companies, including market makers.

How Does Payment for Order Flow Work?

Securities brokers like Robinhood, Charles Schwab, and TD Ameritrade traditionally receive multiple sources of revenue. They receive fees from their clients in the form of trading commissions, sales commissions on mutual funds and other products, margin account fees, and investment advisory fees. However, these matters have changed with the emergence of commission-free trading.

Advantages and Disadvantages of Payment for Order Flow

A brokerage firm is obligated to obtain the best execution of its clients’ orders, which is reasonably available. Price, execution speed, and the ability to meet demand are all criteria for determining where to route the order. Securities brokers are required to regularly review their clients’ orders and identify where they receive more satisfactory executions.

What Does PFOF Mean for Individual Investors?

For investors who trade stocks regularly, the conflict between zero commissions, payment for order flow, and best execution can be difficult to assess. There is conflicting research on whether payment for order flow actually improves the quality of order execution. While the revenue generation through payment for order flow has helped brokerages push down trading commissions for retail investors, the increase in retail investment activity and venture capital has put payment for order flow under regulatory scrutiny. Some of these benefits could disappear if the rules change.

Source: https://www.thebalancemoney.com/payment-for-order-flow-5191754