In the US financial markets, payment for order flow is a practice in which brokers receive compensation for routing their clients’ orders to certain market makers or liquidity providers. The market makers or liquidity providers pay for the order flow because they can use it to trade in the market and potentially earn a profit.
Payment for order flow is a common practice in the United States, where it has been a longstanding part of the financial landscape. It is also practiced in some other countries, including Canada, the United Kingdom, and certain other countries in Europe.
In some countries, payment for order flow is not allowed or is heavily regulated. For example, in Australia, payment for order flow is generally prohibited, and brokers are required to demonstrate that they are providing the best possible execution for their client’s orders.
The use of payment for order flow can be controversial, as it may create conflicts of interest between brokers and their clients. As a result, regulators in various countries have implemented different rules and regulations to address these concerns and ensure that brokers are acting in the best interests of their clients when selling order flow.
Payment for Orderflow Explained in Simple Terms
Imagine you own a biscuit company and you want to sell your biscuits to stores/directly to customers, and you want to get the best price for it. You can either sell it directly to customers who are looking for buying a biscuit from you, or you can sell it to a wholesaler who will then sell it to other customers across the country.
If you sell the directly to a customer, you will get the full price that the customer is willing to pay. However, if you sell it to a wholesaler, you will get a lower price but a commitment of large volume transactions, and also the wholesaler will take on the responsibility of finding other local stores/customers to buy the biscuits.
In the world of finance, brokers play a similar role to the wholesaler in this example. When a client places an order to buy or sell a stock, the broker can either send the order directly to an exchange to be executed, or it can sell the order flow to another market participant, such as a high-frequency trading firm.
The market participant that buys the order flow can then use it to trade in the market and potentially earn a profit. The broker earns a fee for selling the order flow, but the client may not get the best price for their trade because the broker is more incentivized to sell the order flow to the firm that is willing to pay the most, rather than routing the order to the exchange that would provide the best execution for the client.
What is Orderflow?
Order flow refers to the buying and selling orders that are placed by market participants. Brokers can sell the order flow from their clients to other market participants, such as high-frequency trading firms or liquidity providers. These firms are willing to pay for the order flow because they can use it to trade in the market and potentially earn a profit.
History of Payment for Orderflow
The practice of payment for order flow has a long history in the financial markets. It began in the United States in the 1970s when market makers began offering brokers compensation for routing their clients’ orders to them. At the time, this was seen as a way to increase liquidity in the market and improve the efficiency of the trading process.
Over time, the practice of payment for order flow became more widespread and controversial. Some critics argued that it created conflicts of interest between brokers and their clients, as brokers may be more incentivized to sell order flow to the firms that were willing to pay the most for it, rather than routing the orders to the exchange that would provide the best execution for the client.
In the United States, exchanges primarily generate income through the distributing datafeeds. To increase transaction volume and improve the quality of their data, exchanges offer rebates to brokerage firms to incentivize order flow. These rebates are structured according to a maker-taker model, where exchanges pay rebates for providing liquidity (limit orders) and charge fees for taking it away (market orders).
How Retail Traders Benefit from Payment for Orderflow
Improved order execution: By directing orders to liquidity providers that are willing to pay for order flow, brokerage firms may be able to secure better prices for their client’s orders. This can result in improved order execution and potentially lower trading costs for retail traders.
Increased liquidity: Payment for order flow can also help to increase liquidity in the markets, which can make it easier for retail traders to enter and exit trades.
Lower trading costs: Some brokerage firms pass on a portion of the payment they receive from liquidity providers to their clients in the form of lower trading costs or rebates. This can be a benefit to retail traders who are looking to minimize their trading costs.
List of Brokers in the United States that accept payment for order flow includes
6)Charles Schwab Corporation,
List of Brokers in the United States who don’t receive payment for order flow
Payment for Orderflow in India
In India, when a trade is placed through a broker’s platform, it is immediately sent to the exchange for execution. The exchange earns revenue by charging a fee for each transaction that takes place. All trades are routed from broker order management systems directly to the exchange and not via market makers and in India still the concept of dark pools doesnt exists. Payment for Orderflow is still not legal in India