Examine the pricing and execution details.
Because it’s increasingly usual for brokerages to offer free transactions, the cost isn’t as important. However, for active traders who want their deal executed at the best available price — even if it’s only a few pennies — the controversial practice of payment for order flow, whether or not the brokerage accepts it, and how much they charge for it, may be a consideration in which brokerage you choose.
So, what exactly is payment for order flow? It becomes a little more complicated, but here’s a high-level overview.
Order flow payment
When you place a trade with a broker, the broker may forward the trade to a third-party market maker, which is essentially a huge financial institution or bank that actually performs the trade, linking buyers and sellers. Market makers make money by purchasing a security from a seller and then selling it to another buyer for slightly more, frequently for a difference of cents. However, when done on a large scale, those cents might add up to significant revenue for the market maker.
It’s in a market maker’s best interest for brokers to send them as many transactions as possible, and they may be ready to pay brokers to send them trades. And the broker is said to take payment for order flow if it accepts those payments and sends trades to the paying market maker.
Is it a terrible idea to pay for order flow?
Some brokerages, like as Merrill Edge, tout the fact that they do not charge for order flow, emphasising the fact that market makers fight for their orders. Proponents of payment for order flow, on the other hand, believe that the money they get from market makers allows them to keep trading costs low for ordinary investors.
Brokers who do not charge for order flow, on the other hand, say that customer trades will be executed at better prices because the broker routes the trade based on the best available pricing. According to critics of the payment for order flow system, it might create a conflict of interest for brokers, since they may direct transactions to the market maker who pays them the most, even if it means a lower execution price for the trader.
For example, in 2020, the SEC charged Robinhood with misrepresenting its payment for order flow procedures. Robinhood claimed that its execution quality was comparable to or better than that of its competitors, but the SEC determined that Robinhood actually supplied poorer transaction pricing, owing in large part to its “unusually high” payment for order flow rates. According to the SEC, between 2015 and 2018, these lower pricing cost customers $34.1 million.
Bottom line: If execution pricing is a problem for you, research the quality of a broker’s execution before investing. However, if you’re a rookie investor who doesn’t want to trade frequently and is focused on long-term gains, execution price shouldn’t be a major concern.
Consider the following: tools, education, and features
If you’re new to investing, you should search for a brokerage that provides free instructional tools like live webinars, comprehensive how-to guides, video lessons, glossaries, and more.
And, if you want to keep learning about sophisticated trading methods like options, look into how well the broker assists its clients in understanding the hazards of such tactics. This might include assistance from an on-call customer service team, a live chat facility, or clear and detailed instructions on how to use these investment products safely.
Another useful feature to look for is fractional shares, which allow investors to buy stock or ETFs by the dollar amount rather than the number of shares.
