Evaluating ‘Free’ Trading Apps: Payment for Order Flow Explained
Introduction
Zero-commission trading has exploded in popularity thanks to sleek mobile apps that promise retail investors the ability to buy and sell stocks “for free.” From college students dabbling in the market to experienced traders looking for low costs, millions have flocked to these platforms. If there are no ticket charges, how do these brokers stay in business? The answer is often a controversial practice called Payment for Order Flow (PFOF). Understanding PFOF is essential for evaluating whether a so-called free trading app is truly in your best interest.
What Are Free Trading Apps?
Free trading apps are brokerage platforms that advertise zero commissions on stock, options, or ETF trades. Popular names include Robinhood, Webull, SoFi, and Public. Their intuitive interfaces, instant account approvals, and gamified push notifications have lowered the barrier to entry for investors worldwide. Traditional full-service brokers typically charged $4–$10 per equity trade; today’s app-based brokers boast a $0 ticket cost and often no minimum deposit. This shift has democratized access to markets, but it has also created new revenue models that rely on customer activity in less transparent ways.
The Hidden Revenue Model: Payment for Order Flow
PFOF is the primary means by which many zero-commission brokers generate income. Instead of sending your trade directly to a public exchange, the broker routes it to a market maker who pays the broker for the privilege of executing that order. These wholesale market makers include firms such as Citadel Securities, Virtu, and Two Sigma. The market maker then fills the order, earns the bid-ask spread, and rebates a fraction of its profit back to the broker.
While the broker can legitimately claim it did not charge a commission, it still monetizes each trade through these rebates. In 2023, some popular app-based brokers disclosed hundreds of millions of dollars in quarterly PFOF revenue alone. Critics argue that this structure creates an inherent conflict of interest: the broker may choose the highest-paying market maker rather than the one offering the best execution quality for the customer.
How PFOF Works Step-by-Step
1. Customer Submits Order
You open your trading app, tap “Buy 10 shares of XYZ at Market,” and hit confirm. The request is transmitted to the broker’s order routing system.
2. Broker Routes to Market Maker
Instead of posting the order to the New York Stock Exchange or NASDAQ, the broker sends it to a pre-arranged wholesale market maker that has signed a PFOF agreement.
3. Market Maker Fills the Order Internally
The market maker either matches your order against its own inventory or pairs it with another client’s order. Because it avoids exchange fees and can capture the spread, the fill is profitable even if it offers you a slightly improved price compared with the public quote.
4. Rebate Paid Back to Broker
The market maker pays the broker a small fee—often fractions of a cent per share. For a high-volume broker handling millions of transactions daily, these rebates add up quickly.
5. Trade Confirmation Returned
Your app lights up green, confirming your 10-share purchase. From the user’s viewpoint, the process feels seamless and instant, with no visible cost.
Benefits Claimed by Brokers
Proponents of PFOF argue that retail traders still win for three main reasons. First, customers avoid explicit commissions, reducing the cost to enter or exit a position. Second, market makers often provide “price improvement,” meaning the fill occurs at a price slightly better than the national best bid or offer. Third, competition among wholesalers allegedly pressures them to keep spreads tight, indirectly benefiting end users.
Studies by broker-friendly analysts show that average price improvement per 100-share order may amount to a few cents. For frequent traders making small transactions, these pennies can offset what would previously have been multi-dollar commissions.
Potential Downsides for Retail Investors
Despite the above benefits, several risks accompany the PFOF model. The most notable is the conflict of interest: routing decisions may prioritize rebate size over execution quality. In extremely volatile markets, milliseconds matter, and an inferior fill can cost more than a flat commission would have.
Another concern is the encouragement of overtrading. Because commissions appear to be zero, users may feel tempted to trade excessively, turning investing into a dopamine-chasing game. Higher trade volume benefits the broker and market maker via more rebates, while the investor shoulders market risk.
Additionally, price improvement statistics can be opaque or selectively reported. A broker may tout average savings but omit outliers where customers received significantly worse fills. Without granular transaction-level data, retail traders cannot verify claims easily.
Regulatory Landscape and Changes
The U.S. Securities and Exchange Commission (SEC) requires brokers to disclose PFOF arrangements in Rule 606 reports, but critics say these PDFs are dense and hard for laypeople to decipher. In 2022, the SEC proposed sweeping reforms, including potential auction mechanisms for retail orders and stricter best execution requirements. European regulators largely prohibit PFOF, viewing it as incompatible with MiFID II’s “no inducements” principle. Canada bans it outright for similar reasons.
Should the SEC finalize new rules that curtail or ban PFOF, the business model of many free trading apps would face major disruption. Brokers may have to introduce small per-trade fees, raise account minimums, or pivot to subscription models to compensate—changes that could reshape retail brokerage once again.
Tips for Evaluating a Zero-Commission Broker
If you plan to open or keep an account with a free trading app, consider the following checklist to protect your interests:
Compare Execution Quality Reports
Look at effective spread statistics and price-improvement rates, not just headline commission claims.
Check Order Types Offered
Limit orders and conditional orders give you more control than simple market orders, reducing slippage risk.
Monitor PFOF Dependency
Publicly traded brokers reveal quarterly PFOF revenue in their earnings. If a platform relies heavily on it, be aware of the incentives at play.
Assess Educational Resources
Apps that provide solid tutorials, risk warnings, and long-term investing content are less likely to push users toward speculative day trading.
Understand Additional Fees
Zero commission does not mean zero cost. Look for transfer fees, margin interest, and premium subscription tiers.
Conclusion: Making Informed Choices
Commission-free trading apps have undeniably opened doors for a new generation of investors, but there is no such thing as a free lunch. Payment for Order Flow subsidizes the user experience while introducing hidden costs and potential conflicts. By learning how PFOF works, scrutinizing execution quality, and staying abreast of regulatory developments, you can decide whether a particular platform aligns with your financial goals. Remember: the best brokerage is not necessarily the cheapest upfront; it is the one that executes your trades fairly, provides transparent data, and supports a disciplined investing strategy for the long haul.