Payment for order flow (PFOF) is the controversial practice that makes zero-commission trading possible. Market makers pay brokers for the right to execute their customers' orders. Understanding PFOF helps you make informed decisions about where to trade and what "free" really means.
What is Payment for Order Flow?
Payment for order flow is a business arrangement between brokers and market makers. Here is how it works:
- You place an order through your broker (like Robinhood or Webull)
- Instead of sending your order to an exchange, the broker sends it to a market maker
- The market maker pays the broker a small fee for this order flow (typically fractions of a penny per share)
- The market maker executes your trade, profiting from the bid-ask spread
The Math: If a market maker pays $0.002 per share for order flow, a broker routing 10 billion shares annually earns $20 million in PFOF revenue. This is why commission-free trading is sustainable.
Why Market Makers Want Your Orders
Market makers are willing to pay for retail order flow because it is profitable. Retail traders, on average, are less informed than institutional traders. This means:
- Retail orders are less likely to be followed by adverse price movements
- Market makers can profit more reliably from the spread
- The flow is predictable and diversified across many small orders
When a market maker buys from a retail seller, they are more confident they can resell at a profit. Institutional orders are riskier because institutions often have better information.
The Controversy Around PFOF
Arguments Against PFOF
- Conflict of interest: Brokers may route orders based on who pays them the most, not what is best for customers
- Price execution: Customers might get worse prices than they would on an exchange
- Lack of transparency: Most investors do not know their orders are being sold
- Market structure concerns: Concentrates power in a few large market makers
Arguments For PFOF
- Zero commissions: Retail investors save billions in trading fees
- Price improvement: Market makers often execute at prices better than the quoted spread
- Democratized access: Anyone can trade without worrying about commission costs
- Efficient execution: Market makers provide reliable, fast fills
Regulatory Scrutiny
The SEC has considered banning or restricting PFOF. Some countries, including the UK and Canada, have already banned the practice. The debate over whether PFOF helps or hurts retail investors continues.
How PFOF Affects Your Trades
Execution Quality
The key question is whether you get worse prices due to PFOF. Studies show mixed results:
- Market makers often provide "price improvement" - executing your order at a slightly better price than the quoted spread
- However, the amount of price improvement may be less than if the order went directly to an exchange
- For small orders in liquid stocks, the difference is typically minimal
- For larger orders or less liquid stocks, execution quality matters more
Example Scenario
You want to buy 100 shares of a stock with a bid of $50.00 and ask of $50.05:
- On exchange: You would pay $50.05 (the ask price)
- Through market maker: You might pay $50.04 (1 cent price improvement)
- Your savings: $1.00 on this trade
This sounds good, but critics argue you might have gotten $50.03 on the exchange through a limit order or better routing.
Which Brokers Use PFOF?
Heavy PFOF Users
- Robinhood: PFOF is their primary revenue source
- Webull: Uses PFOF for commission-free trading
- E*TRADE: Receives PFOF but offers other features
- TD Ameritrade/Schwab: Uses PFOF but also focuses on execution quality
No PFOF
- Fidelity: Does not accept PFOF for equity orders, focuses on price improvement
- Interactive Brokers (Pro): IBKR Pro routes directly to exchanges without PFOF
How to Check Your Broker's PFOF
SEC Rule 606 requires brokers to publish quarterly reports on their order routing practices. You can find:
- Which venues receive order flow
- How much PFOF the broker receives
- Execution quality statistics
Search for "[Your Broker] Rule 606 report" to find this information.
Does PFOF Matter for Your Trading?
Probably Does Not Matter If:
- You trade small quantities (under 1,000 shares)
- You trade liquid, large-cap stocks
- You are a long-term investor, not a frequent trader
- The savings from zero commissions outweigh any execution cost
Might Matter If:
- You trade very frequently (hundreds of trades per year)
- You trade larger positions where pennies per share add up
- You trade less liquid stocks or options
- Execution timing is critical for your strategy
Strategies to Mitigate PFOF Impact
1. Use Limit Orders
Limit orders let you specify your price, reducing the chance of poor execution. If your limit order is not filled at your price, it simply is not executed.
2. Trade Liquid Securities
Highly liquid stocks like AAPL, MSFT, or SPY have tight spreads regardless of routing. PFOF impact is minimal on these securities.
3. Avoid Market Orders in Volatile Conditions
During high volatility, spreads widen and execution quality suffers. Use limit orders or wait for calmer conditions.
4. Consider Non-PFOF Brokers for Large Trades
If you are moving significant capital, the better execution at a broker like Fidelity or Interactive Brokers may be worth it.
5. Review Your Execution Quality
Some platforms show price improvement statistics on your confirmations. Monitor whether you are getting good fills.
The Bigger Picture
PFOF enabled a revolution in retail investing. Before zero-commission trading, a $7 commission on a $100 trade represented a 7% cost. That barrier is now gone.
The trade-off is that brokers make money in less transparent ways. Whether this is a good deal for investors depends on your trading style and volume. For most retail investors, the commission savings far exceed any execution costs from PFOF.
Track Your Actual Trading Costs
Pro Trader Dashboard helps you analyze your trading performance including actual execution prices. See what your trading is really costing you.
Summary
Payment for order flow is how brokers offer free trading while still making money. Market makers pay for the privilege of executing your orders, profiting from the spread. While this creates potential conflicts of interest, it also eliminated trading commissions for millions of investors.
For typical retail investors trading moderate amounts in liquid stocks, PFOF's impact is minimal. The benefits of zero-commission trading likely outweigh any execution costs. However, if you trade actively or in size, consider brokers that prioritize execution quality over PFOF revenue.
Want to understand more about how your trades work? Read our guides on order routing and commission-free trading.