Payment for Order Flow (PFOF)
Compensation that a broker receives from a market maker or wholesale trading firm for routing customer orders to that firm for execution.
What is Payment for Order Flow?
Payment for order flow (PFOF) is the practice in which a retail broker-dealer receives compensation from a market maker or wholesale broker in exchange for routing customer orders to that firm for execution rather than sending them directly to a public exchange. The market maker profits from the spread between the bid and ask prices on the routed orders. Brokers use PFOF revenue to subsidize zero-commission trading for retail clients. The practice is controversial because it may create a conflict of interest: brokers are supposed to achieve best execution for clients, but PFOF incentivizes routing to the highest-paying market maker rather than the venue offering the best price. The SEC has studied PFOF extensively, and it is banned in several countries including the UK and Canada.
Example
A retail investor places a market order to buy 100 shares at Robinhood. Rather than routing the order to the NYSE or Nasdaq, Robinhood sends it to Citadel Securities, which pays Robinhood a fraction of a cent per share. Citadel executes the order and earns the bid-ask spread. Robinhood generates revenue without charging the customer a commission — but critics argue the customer may have received a slightly better price on a lit exchange.