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Payment for Order Flow (PFOF)

Payment for Order Flow (PFOF) is a practice in which brokers receive compensation from third parties, such as market makers or exchanges, for routing customer orders to them. PFOF allows brokers to offer commission-free trading to retail investors, but it has been controversial because it may create a conflict of interest. Critics argue that brokers may prioritize routes that pay more, potentially impacting the quality of trade execution.

Example

A retail brokerage firm receives payment for order flow from a market maker, allowing it to offer commission-free trades to its customers while earning revenue from routing orders.

Key points

• A practice where brokers receive compensation for routing orders to specific market makers.

• Enables commission-free trading but may create potential conflicts of interest.

• Controversial due to concerns about prioritizing compensation over trade execution quality.

Quick Answers to Curious Questions

It raises concerns about conflicts of interest, as brokers might route orders based on compensation rather than ensuring the best execution for clients.

It allows brokers to offer commission-free trading, reducing the costs associated with buying and selling securities.

Regulators require transparency in PFOF arrangements to ensure that brokers disclose any potential conflicts of interest to investors.