Is PFOF bad?
PFOF is getting regulators’ attention because it may prevent retail investors from getting the best trade executions. Those few pennies per 100 shares have to come from somewhere. If you’re trading thousands of shares a day, PFOF is a big concern, but for long-term-focused retail investors, it’s really a minimal charge, in the range of 10 to 30 cents per 100 shares.
Do all brokers use PFOF?
Not all brokers use PFOF, and the amount of payment per share varies across brokers. Fidelity is one broker that doesn’t accept PFOF, and it has repeatedly won a spot in our top picks for order execution. On the other side of the spectrum, Robinhood was being paid as high as 77 cents per market order of 100 shares, according to its 2022 third quarter Rule 606 report.
What is SEC Rule 606 reporting?
Rule 606 reports show where brokers are routing their trades and how much payment from order flow they receive from market centers. The SEC requires each broker to file a Rule 606 report quarterly.
The two most important categories of information are, first, a table showing which market centers received orders and their respective share; and second, the payment for order flow (PFOF) the broker receives, on average, from each market center.
Unfortunately, Rule 606 reporting isn’t standardized well. There’s no universal measure that can be pulled and used to conduct an apples-to-apples comparison between PFOF brokers.
Who is the fastest broker?
In our testing, tastytrade’ downloadable platform stood out as lightning-fast. We think speed played a part in every decision tastytrade made while developing its platform. But we can’t say for certain which broker has the fastest execution, because internet connectivity plays a very large role.
Can brokers trade against their customers?
Some brokers might claim they don’t accept PFOF, but they trade against you instead. Operating a market maker and using an algorithm to pick and choose which customer orders you want to bet against certainly sounds like a losing proposition for the customer. However, as long as the broker meets the Best Execution standards, it's perfectly legal, and it's not technically PFOF. In our view, this sure sounds like profiting from order flow.
How the industry interprets the definition of PFOF is subject to much debate. For example, with options trading, if you think about "payment" more broadly as "profiting," then all brokers accept PFOF for options. More specifically, if the online broker receives rebates from the exchanges they route their customer options traders to (which they all do), then they are profiting from their customer order flow. So, isn't that PFOF? Our take is that yes, it is, but technically speaking, it's debatable.
What about equities, you may ask. Well, that's a bit more complicated. Some online brokers own and operate an Alternative Trading System (ATS). These firms technically do not accept PFOF; however, the ATS of each firm is a separate legal entity and is undoubtedly not operated as a nonprofit. So, are they generating revenue from their order flow? How does the overall order quality compare to other brokers who do not operate an ATS? In most cases, we believe these ATSes benefit customers, but we don't know with certainty.
Similarly, some online brokerages own and operate a market maker. In their disclosures, they acknowledge that they can internalize orders, meaning trade against their own customer orders. As a result, they keep any profit or loss realized from the trade. That also sounds like a losing proposition for the customer. However, as long as the broker meets the Best Execution standards, it's perfectly legal, and it's not technically PFOF. In our view, this sure sounds like profiting from order flow.
What does order execution quality mean?
Order execution quality is how much you pay or receive on a trade compared to the nationally published quote on a security, called the National Best Bid and Offer (NBBO). If you buy a stock less than the current offer, you are getting a high quality fill, and the more you save, the higher quality it is. The same relationship holds for selling stock. If you receive more per share than the published bid price, you are getting a high quality fill.
How do I get the best order execution?
A variety of factors come into play with your broker’s ability to provide quality order execution. If you’re trading large amounts of shares frequently, best execution is critical. Interactive Brokers’ sophisticated order routing algorithms make the broker a favorite for professionals. If you’re trading a few hundred shares a few times a year, you don’t need a library of algorithms to get satisfactory execution.
Here’s a list of factors in your control that directly impact execution quality:
- What stock is being traded. Companies in the S&P 500, for example, all boast extremely large market caps (they’re worth billions) and high average daily volumes of millions of shares per day. This means there is a lot of liquidity (buyers and sellers), which translates into consistently tight spreads (the difference in price between the bid and the ask). On the flip side, a micro-cap stock (or a penny stock traded on a non-major market, e.g. OTCBB) that trades only 10,000 shares per day, on average, has little liquidity. As a result, spreads are often very wide, which means you are less likely to obtain a quality fill on your order.
- Time of day. The first 15 minutes of each trading day are statistically the most volatile, meaning stocks fluctuate the most during these times. More specifically, bid / ask spreads are wider, on average. Similarly, pre- and post-market hours have much wider spreads, including far less liquidity, as compared to regular market hours.
- Order type. The most commonly used order type is a market order, which basically says, “buy or sell these shares immediately at whatever the best current market price is.” Limit orders, the second most commonly used order type, on the other hand, say, “buy or sell these shares only at the price I set, or better.” As one can imagine, limit orders may sometimes take longer to fill (if they fill at all), but, compared to a market order, have a better chance of being filled at a better price.
- Order size. According to the Wall Street Journal, "nearly half of all trades in the U.S. stock market are in odd-lot sizes—in which fewer than 100 shares change hands." However, regulation does not currently cover these odd lot orders, so it is uncertain if everyday investors are getting the best order execution quality. As a result, trading using round lots, e.g., 100 shares, instead of an odd lot, e.g., 57 shares, may result in a cleaner fill from your online broker.
What factors affect order execution quality?
There are four factors that every investor can control that will directly impact the quality of their buy and sell orders.
- The stock traded (more liquidity, the better).
- The time of day (avoid trading immediately after the opening bell and during post-market hours).
- The order type used (non-marketable limit orders are best, but you may not get your order filled).
- The number of shares traded (try to stick to round lots, e.g., 100 shares).
Why does my online brokerage care about order execution quality?
Your online brokerage cares about order execution quality because its institutional clients care deeply about order execution quality, and institutions trade much more than us retail customers. If a brokerage trades off poor executions in exchange for maximizing PFOF, its biggest customers will take their business elsewhere.
Are PFOF and execution quality the same?
PFOF and execution quality are related, but it’s not a perfect relationship. PFOF is a cost embedded in the trade, which means that it’s likelier that brokers that accept a ton of payment for orders will pass along poorer executions, but there are other factors that affect execution, such as speed and liquidity.
Do large brokers have better order execution quality?
Large brokers have the ability to deliver better order execution quality because they can negotiate harder with trading venues. Whether that benefits clients or the broker’s bottom line will depend on whether they accept PFOF and how much they pocket. Larger brokers also have access to more markets and bigger budgets for building speedy trading platforms.
Are $0 stock and ETF trades good for everyday investors?
Yes, $0 stock and ETF trades are good for everyday investors. Thanks to a September 2019 pricing war, most online brokers cut their baseline stock and ETF commissions to $0 per trade. Though brokerages make some money from payment from order flow, the typical buy-and-hold investor won’t feel it nearly as much as a $6.95 commission or, heaven forbid, an expensive front loaded or level-load mutual fund.
Does order size impact order execution?
It’s not yet clear how much order size impacts execution. According to a Nasdaq blog post, exchanges don’t differentiate between round and odd lots, but algorithmic and routing traders do tend to emphasize round lots for stocks under $500 per share. We think choosing and holding the right stocks for the right length of time will have a far bigger impact on your success than concerning yourself about only buying in round lots.
What is price improvement?
Price improvement means that your buy or sell order was filled at a price better than the National Best Bid and Offer (NBBO), which is the highest bid and the lowest offer for a stock at any moment. For a detailed, streaming real-time view of what the current bid and ask is for any stock, traders use Level 2 quotes.
What are the most common order types?
Market and limit orders are the two most common order types used by retail investors. While every broker has an auto (smart) routing option by default, some brokers offer level 2 quotes with direct-market routing, giving traders the ability to route their orders wherever they’d like. Some brokers even pass along any market rebates and liquidity charges associated with direct market routing.
Do any brokers show orders that receive price improvement?
In 2015, Fidelity became the first to begin showing per order and cumulative price improvement across each account (Charles Schwab became the second broker to do so in 2018). For month-to-date, year-to-date, and previous 12-month periods, customers can see exactly how much they paid in commissions, how many trades received price improvement, and the total price improvement. Price improvement means a buy order was executed lower than the best ask or a sell order was executed higher than the best bid at the time of the trade.
Does TD Ameritrade use PFOF?
TD Ameritrade accepts payments for order flow (PFOF), but the broker’s website claims it prioritizes best execution.
How fast is TD Ameritrade execution?
TD Ameritrade’s executions of market orders are as fast as .04 seconds, according to its website. It also claims that 98% of its market orders saw price improvement and the net price improvement for trades between 1 and 1,999 shares was $1.32.
Since there is no single universal industry metric yet that identifies order execution quality, we focused our evaluation primarily on payment for order flow and each broker’s process for routing orders to achieve price improvement. Publicly available data, including third-party industry reports, SEC 606 reports, and self-reported execution data from each broker was also taken into consideration. Finally, it should be noted that all order sizes were considered relevant, from less than 100 shares to 1000+ shares or more.
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1 Fidelity Sell orders are subject to an activity assessment fee from $0.01 to $0.03 per $1,000 of principal. Options trading entails significant risk and is not appropriate for all investors. Certain complex options strategies carry additional risk. Before trading options, please read Characteristics and Risks of Standardized Options. Supporting documentation for any claims, if applicable, will be furnished upon request.
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