What Is Payment for Order Flow and What Does It Cost You?

Your broker has to tell you where it sends your orders. SEC Rule 606 requires brokers to publish quarterly reports showing which venues received their customers’ orders and what payments, if any, they received from those venues in return. Those payments are payment for order flow.

How the arrangement works

A retail broker receives your order. It can send that order to an exchange, or to a wholesale market maker, a firm that fills large volumes of retail orders from its own inventory. Market makers pay many brokers for that flow.

Why pay for it? Retail orders, taken together, tend to be small and unrelated to one another, which makes them less risky to trade against than orders from large, informed institutions, and a market maker who can fill them profitably across a very large number of trades will pay for steady access. The broker takes the payment. You get a fill, often at the national best bid and offer or slightly inside it.

That last part is called price improvement. It is real. Some confirmations show it, and it is the main argument made in favor of the model.

A sum on price improvement

The sum shows what you can measure. What you cannot measure from a single fill is the counterfactual: what the same order would have received if it had been routed somewhere else at the same instant.

The debate

The case for the model runs like this. Retail orders get filled at or inside the NBBO, often with price improvement. The payment helps fund commission-free trading. And on a small order in a liquid stock, supporters say, the fill arrives quickly at the quote or better, which they argue is at least as good as a retail trader would get by sending the same order straight to an exchange and waiting in the queue there.

The case against is a conflict of interest. A broker paid by a market maker has a reason to route to whichever firm pays most, and the firm that pays most is not necessarily the one that gives your order the best price. Brokers owe customers a duty of best execution, and critics argue that the payment creates pressure against it, while supporters argue that the execution statistics show retail orders are well served.

Both sides point to data. Which side the data favors on average depends on the broker, the market maker, the stock and the period measured, and the honest way to form a view is to look at the reports for the brokers you actually use.

How to look it up yourself

Rule 606 routing reports. Your broker publishes these, usually in a disclosures or legal section of its website. They list the venues that received orders, broken out by order type, and the net payments received, with separate sections for different kinds of securities, so find the one covering the stocks you trade. Rule 606 also lets you ask your broker for details on where your own orders were routed.

Rule 605 execution quality reports. Market centers publish these. They measure execution against the NBBO, including how often orders received price improvement and how fast they were filled. They are dense. Read them for the order sizes you actually trade.

What you can control

Use limit orders when the price matters. A limit sets the worst price you accept, wherever the order is routed. Check your platform’s default order settings, since a default market order hands every decision on price to the routing. And when a fill looks wrong, work out whether the quote moved first, using why a fill differs from the chart as a guide.