Order Flow No More?
Trading for retail investors, and in general has evolved so much in the last few decades. Nowadays, you don’t have to travel all the way to the Big Apple just to make a trade. You have a lot more investment options, and as a whole it’s more accessible. What was once considered a rich man’s place is now open to everyone, and the recent evolution of fractional shares has helped boost this a lot. In recent years, however, the biggest difference has to be the brokerage industry’s move towards zero-commission trading, heavily reducing the amount of money needed to make trades.
Zero-commission trading is a great idea, and it can be executed very well. However, there has been controversy regarding it due to the idea of payment for order flow. In this system, the stock buyer places an order on their brokerage account, which is received by the broker. Then, the brokerage routes the order to a 3rd party client who completes the transaction, and the buyer’s order is fulfilled. This doesn’t sound too bad, but the 3rd party clients pay the brokerage firms a fee in exchange for the orders, and the 3rd parties make profit on the spread by finding the most favorable terms. When this occurs, it creates a conflict of interest as investors aren’t getting the best execution of their trades due to the existence of a third party, and this was best displayed during the meme stock mania where brokers like Robinhood barred traders from trading specific securities while having links to 3rd party clients like Citadel.
Payment for order flow came into heavy fire after that with Congressional hearings occurring after the fiasco, and it looks like the SEC is ready to take their action more than a year after. SEC Chair Gary Gensler outlined the plans, which include requiring brokerage firms to route their orders into auctions in order to increase competitiveness compared to a few market makers controlling all order flow. Another part includes a proposal for a market wide “tick size,” or a minimum pricing increment for exchanges and market makers as stock exchanges are limited to pricing by the penny. Brokerages who use payment for order flow and high-speed trading firms were major critics of the rules, but Wall Street viewed it as a way to make the markets fair and prevent it from becoming more top-heavy. There are still a sizable number of firms like Invstr who don’t utilize the system, so this isn’t hurting the whole industry. If these SEC rules were to go into effect, it could be a win for retail investors as they were the ones hurt the most by this. If anything, it’s impressive that Gensler cited Reddit investors as reasoning for these rules, so Wall Street Bets has made it to the top of the stock market.
I am not a financial advisor and my comments should never be taken as financial advice. Investments come with risk, so always do your research and analysis beforehand.