Payment for Order Flow and Why Buying $GME is Still Helping Wall Street

Right now a subreddit r/WallStreetBets is driving up the price of Gamestop ($GME) stock from $30 -> $170 to spite short sellers, here’s an article detailing why this is still making funds and large institutions huge amounts of capital.

TLDR: Buying stocks on “commission free” brokerages make the brokerage money as well as large funds

What is a Payment for Order Flow?

Payment for order flow is what every commission free brokerage is using to allow customers to purchase stocks without charging them a commission. Brokers and platforms such as: Robinhood, Charles Schwabb, TD Ameritrade and E-Trade. When you put in an order on these brokerages your order doesn’t go to the exchange, for example NYSE or NASDAQ, your order goes to a market maker that can choose to buy your order and give it to you within a threshold of NBBO (national best bid and offer). The order will get a fair market price but the catch here is these large institutions can make fractions of a cent and bundle orders from users and make money from executing these trades better. Effectively they are making money from the spread and executing the trade at a better price.

Here’s a diagram (ref: https://www.marketsmuse.com/tag/payment-for-order-flow/) depicting the flow:

These brokers can make even more money from options because the spread on options are usually a lot larger than stocks. Here’s a chart from (https://www.cnbc.com/2020/08/13/how-robinhood-makes-money-on-customer-trades-despite-making-it-free.html)

This chart details how much different brokerages make from payment for orders and how much they make per rate of 100 shares traded. As you can see it is quite a profitable business.

Is there evidence of this?

Due to SEC rules 606 and 607 (reference here: https://www.sec.gov/news/press-release/2018-253), brokerages using payment for order flows must disclose this information. Here you can see an itemized list from Robinhood:

Any broker using a Payment for Order Flow must disclose this information to it’s users.

Conclusion

This type of order flow allows for brokers to make money alongside large institutions. Buying a bunch of $GME Gamestop stocks and options isn’t really sticking it to Wall Street — with every trade executed on a commission free trading brokerage, this means money going into large funds for executing the trades. With people being locked in home from Covid these types of trades have increased. Retail trading is up to 25% of daily volume on the stock market (https://markets.businessinsider.com/news/stocks/retail-investors-quarter-of-stock-market-coronavirus-volatility-trading-citadel-2020-7-1029382035). It will be interesting to see how this plays out for $GME and investors as well as the profit increase this type of traffic and attention brings these payment for order flow brokers.

Disclosure: The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product. It is only intended to provide education about the financial industry.