I’ve heard something about payment for order flow, but I’m not entirely sure how it works or what the implications are for my trades. Can someone explain this in detail and whether it affects the prices I get when buying or selling stocks?
Hi there,
Great question! Brokers like Robinhood and Webull make money through a few different methods even though they offer commission-free trading.
One of the primary methods is through something called payment for order flow (PFOF). Additionally, here’s a breakdown of other ways they generate revenue:
- Payment for Order Flow (PFOF): When you place a trade on Robinhood or Webull, they route your order to market makers (big financial institutions that facilitate trading). These market makers pay the broker for the privilege of executing your trade. The reason they do this is that they can make money off the small difference between the buy (bid) and sell (ask) prices of the stock.
- Interest on Cash Balances: Both platforms earn interest on any uninvested cash in your account.
- Margin Lending: If you trade on margin (borrow money to trade), they charge you interest on the amount borrowed.
- Premium Services: Both platforms offer premium subscription services (like Robinhood Gold) that come with extra features, and they charge a monthly fee for these.
As for how PFOF affects your trades:
- Impact on Trade Prices: The idea is that market makers try to offer competitive prices to get your order. However, there can be slight differences compared to what you might get on other platforms. For most small investors, these differences are usually minor, but they can add up over time. So, while PFOF does have some impact on the exact prices you get, it’s typically minimal for most trades. The benefits of commission-free trading often outweigh these small differences for casual investors.
- Best Execution: Brokers are required to ensure you get the best possible price when you buy or sell, but the exact price might still differ slightly because of the PFOF model.
Hope this helps clear things up!
Best,
Andris