Payment for order flow
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Payment for Order Flow is the practice by some exchanges or market makers of paying a broker's firm for routing its customers' orders to them. It is a way to attract orders from brokers. Generally the amount paid is a penny or more per share. Payment for order flow is one of the ways a brokerage firm can make money from executing customers' trades. The firm can also make money by internalizing orders.
Payment for order flow also allows a smaller brokerage, which can't handle thousands of orders at a time, to send orders to another firm to be bundled with other orders for execution. This helps the brokerage firms keep their costs lower.[1]
Upon opening a new account, as well as annually, firms must inform their customers in writing whether they receive payment for order flow and, if so, a detailed description of the type of payments. Firms must also disclose on trade confirmations whether they receive payment for order flow and that customers can make a written request to find out the source and type of the payment for that particular transaction.[2] The big market makers pay hundreds of millions of dollars a year to retail brokers for their order flows.[3]
Order-flow payments subsidize the commission-free trading that became the norm with U.S. retail brokers. However, they are banned in Canada and the U.K. out of concern that the payments discourage brokers from obtaining the best trades for their customers (best execution), and the practice of PFOF has always been controversial. During the late 1990s, the waning days of fractional pricing, some firms that offered zero-commission trades routed orders to market makers that did not keep investors’ best interests in mind. Traders discovered that some of their "free" trades were costing them quite a bit because they weren’t getting the best price at the time the order was executed. The SEC studied the issue in-depth, focusing on options. It found, among other things, that the proliferation of options exchanges and the additional competition for order execution narrowed the spreads, but that "by some measures these improvements have been muted with the spread of payment for order flow and internalization.” The SEC nevertheless allowed to practice to continue, partly because of its role in fostering competition and limiting the market power of exchanges.[4]
References[edit]
- ↑ Payment for Order Flow. Investopedia.
- ↑ Payment for Order Flow. SEC.gov.
- ↑ What Is Payment for Order Flow? Behind the Trading Controversy at Robinhood and Other Brokers.. Barron's.
- ↑ Payment for Order Flow. Investopedia.