Payment for order flow is the money brokerage firms make by sending trade orders to high-frequency traders or market makers.
What is Payment for Order Flow?
When an individual investor places a trade, the brokerage firm sends the trade to a market maker. Market makers are responsible for executing the trade. They can get the best price on an investor’s trade or fulfill it promptly.
Executing a trade can get complicated, however. Sometimes the trade price an investor is looking for doesn’t exactly match the price the market is offering. The difference between these two prices is called the bid-ask spread.
Payment for order flow is controversial. Supporters of the practice say it’s significantly reduced explicit costs for trading, like eliminating commissions, which are flat fees incurred by every trade.
Critics say the practice has replaced transparent commission fees with hidden trading costs that investors might not notice. Some also say payment for order flow creates a conflict of interest: Brokerages may not fulfill trade orders immediately if they wait for the highest-bidding market maker.