Implications of Payment for Order Flow

Payment for Order Flow (POF) is a common practice that has been occurring in the United States markets for a long time now.  This practice, in fact, was happening in the 1980’s with master crafters Bernie Madoff taking the front lead.  The arrangement of POF occurs when a third-party firm pays a broker to send orders including a large amount of retail orders to their firm instead of to the open market. 

When the POF firm gets their orders, they can either pass it on to the market to be filled against existing quotes, or they can execute it themselves which is more probable.  If the buying firm sees an order for $10.10 for example, they can sell the stock to the customer themselves for $10.0999, giving the appearance of giving a price improvement.  Now they’re just inside the bid and they can take advantage of midpoint pricing in dark pools and can possibly buy it back for $10.095. 

Direct high speed data cables connected directly to exchanges allow their computer algorithms to pick up on the National Best Bid and Offer (NBB) fractions of a second before it’s widely represented, allowing them to see a move to possibly $10.08 x $10.09.  If the NBBO hasn’t changed yet and is still showing an offer of $10.10, they’ll give the execution at $10.10 adhering to the best official offer price, and turn around and buy immediately the $10.09 offer they know is coming. 

The implications to the average day trader are that they are the last to have their orders executed because once the POF firms process their orders including all retail customer trades, traders are left searching for what’s still available. 

All too often, when day traders try to sell stock at $10.10 referring to the example above, they act as nothing more than providing a reference price for the firms that get to see the orders first.  Typically, the only way that the daytrader gets to see at the $10.10 price is if the POF firms decide not to sell it themselves, which means in most cases that it’s no longer a good trade.  This is quite a disadvantage.

After talking with several experienced daytraders, the consensus is in, and most daytraders agree that a Limit on Payment for Order Flow would be on the top of their wish list. 

Headquartered in Chicago, Great Point Capital, LLC, is a member of FINRA and has been serving the trading community since 2001. Our mission is to be the leader in the equity day trading community by giving the best traders the tools and support to make the most of their trading careers.  Contact Great Point Capital, LLC today, in either our Chicago Office, or our Austin Office, to learn more about how we can successfully trade together with high performance results.