Due to the retail army of investors’ dissatisfaction with market makers giving an unfair edge to those who dominate the marketplace, payment for order flow has been a hot subject for a while.
Perhaps you’re wondering what paying for order flow entails. According to investopedia, payment for order flow, or PFOF for short, is described as:
“Payment for order flow (PFOF) is the compensation, usually fractions of a penny per share, that a brokerage firm receives for directing orders for trade execution to a particular market maker. The options market is dominated by market makers with the financial resources to meet market making’s considerable risks and liquidity requirements. Payment for order flow is common for options transactions, typically averaging less than $0.50 per contract traded. “
In the old days of trading stocks there was commissions which would set back investors a few bucks per trade. And although now in 2022 there are “Free” brokers should as Robinhood, it bears the question… How “Free” are they?
Robinhood makes money by the following as defined on investopedia: Robinhood is an online discount brokerage that offers a commission-free investing and trading platform. The company gets the vast majority of revenue from transaction-based revenues, including payments for order flow.
In the video below from Bloomberg you see Gary Gensler SEC Chair explain that 90-95% of all trades are not processed on the lit exchange, and the retail investors are not happy about this.
WILL PFOF BE BANNED?
If we want to get down to the bottom of things, it seems that the banning of PFOF would really disrupt the current trading and market structures that exisit.
By Banning payment for order flow would likely make market makers mad because it would eliminate a source of revenue for them. Market makers are firms or individuals that provide liquidity to financial markets by constantly buying and selling securities.
They make a profit by buying securities at a lower price and selling them at a higher price. Payment for order flow is a practice in which market makers receive payment from brokers for directing trading orders to them, rather than to other market makers.
This practice allows market makers to earn additional revenue from the payments they receive. Banning payment for order flow would therefore reduce the revenue that market makers receive, which would likely make them unhappy.