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Commission-Free Brokers: Are You Trading Or Being Traded?

Raph Antoine November 27, 2023

Comment Article On Forum Share:

Raph Antoine November 27, 2023 Comment Article On Forum Share: The EU BANS PAYMENT-FOR-ORDER-FLOW But exchanges will remain ‘Free trading’ often advertised by Brokers may not be as free as you think it is. Often, a shadow transaction you might not know about comes with it – Payment for Order Flow. Your trades are sold, and matched in a ‘Dark Pool’ (in the US) or on an exchange that may have a single market-maker (in the EU). It often results in worse prices. So, the EU stepped in. But what does it mean for you when choosing a broker? Even as these payments are banned, single market maker exchanges may still be around. Be sure you understand the implications of trading through them.

KEY TAKEAWAYS

• PFOF is controversial – PFOF are commissions (aka legal bribes or ‘kickbacks’) paid by financial firms to brokers. They may impact transparency and add conflict of interest.
• PFOF is beneficial to everyone. But only in theory. Buyers pay a lower price, sellers get a higher price, the third party gets a commission, and brokers get a payment without paying the exchange fee. Sounds too good to be true? It is. In practice, numerous studies show that investors lose out in 68% to 86% of cases.
• Identifying a PFOF Exchange may not be obvious. Brokers using PFOF trade on Gettex, Tradegate Exchange or Lang & Schwarz.

How do brokers make money on my Trades? What is Payment-for-order-flow?

PFOF are commissions paid by financial firms to Your broker

TRADITIONAL BROKER

There are two brokerage revenue models

• Regular Model – The broker earns from client commissions, fees, or spreads, provides more transparent order execution through various market venues, and generally holds a lower conflict of interest risk.
• PFOF Model – It relies on payments – called Payment-for-order-flow (PFOF) from third parties for directing orders, often offering lower or zero commission trades but facing transparency issues and higher conflict of interest potential, and is scrutinized in regions like the EU and UK.

So, in a normal course of action, the broker would send your trade to a traditional exchange like XETRA. For that, the broker would have to pay the exchange a fee, since Xetra acts like a transparent middle-man in the transaction. With PFOF, not only the Broker doesn’t pay a fee, but it also receives a commission. So, it’s easier for the Broker to offer zero-commission trades to you.

Who else makes money off my trade? If it looks like a duck and swims like a duck…

In the US, Your order may be executed by Hedge Funds In the US, your order may land in a Dark Pool of a High Frequency Trading Firm like Citadel, which will profit from the transaction. In Europe, a single market maker May have full control In Europe, your order may be sold to a Multilateral Exchange. In theory, that’s probably better than an opaque Hedge Fund, you may say. Except, in practice, these exchanges only include one market maker. So while in theory it’s different, If it looks like a duck, swims like a duck, and quacks like a duck… then probably it is a duck!

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