How do brokers make money with zero commissions on trades? That’s a question many investors are asking. If stock trades are free, one may well assume that there’s something fishy . . . and there is, though there is an ongoing controversy about whether any rules are being broken. The key phrase is payment for order flow (PFOF), which is what brokerage firms receive for directing trades to a particular market maker for execution. These payments are typically fractions of a penny per share, but they add up to substantial sums when cumulated by the volume of trades taking place. The Golden Rule for trading is best execution, which means that brokers are required to get the lowest prices when buying and highest prices for selling on behalf of its clients. As long as this rule is followed, no lines are crossed, but when brokers direct trades to market makers who may be specializing in certain stocks, it becomes a gray area, especially when the trades are done at other than the best
Investment and economic observations by N. Russell Wayne, CFP, MBA. Mr. Wayne is the president of Sound Asset Management, inc. and former Managing Editor of The Value Line Investment Survey.