How Payment for Order Flow Can Affect Brokerage Execution Costs
Summary
The document compares the apparent cost of commission-free brokerage apps with flat-fee brokers. It explains that a zero commission does not make a trade costless: execution at a less favorable price can create an implicit cost through the bid–ask spread or lost price improvement. The cited regulatory analysis says Robinhood orders, especially larger orders, sometimes received less price improvement than competing brokers, with the estimated differences growing by order size. It also describes how routing incentives and access to trading venues can influence execution quality.
Actual costs depend on the security and market conditions. Highly liquid stocks may offer many execution opportunities, while illiquid small-cap securities can have wider spreads and less favorable fills. The document offers no general spread estimate or controlled comparison across brokerages, so its examples do not establish a universal cost ranking. Traders need to compare realized execution prices and available price improvement for their order sizes and securities, alongside any explicit commission.
Key ideas
- Commission-free trading can still have implicit costs through execution quality.
- Regulatory analysis cited in the document found that some Robinhood orders received less price improvement than comparable orders elsewhere.
- Order size may affect the value of price improvement lost through routing choices.
- Execution costs vary with liquidity, so results from a highly traded stock may not generalize to illiquid securities.
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Full text
# How much do brokerage apps cost versus traditional brokerages? # How much do brokerage apps cost versus traditional brokerages? Apps like Robinhood and TD Ameritrade apparently don't adhere well to best price practices and instead are incentivized to widen the spread, adding cost to the trader in the form of what the trade actually executes at. Traditional brokerages adhere to best price practices, supposedly. This question isn't about the fidelity of this maxim. The question is, what are the actual costs? An example would be a brokerage that charges a flat rate of 25dollars on any trade, is charging 2.5% on $1,000, or 0.83% on 3,000dollars. Which is substantially better than Crytpo.com's maker-taker fees which requires 40,000dollar lots to hit about 1.25%. But brokerages like Robinhood are more hard to quantify. What are theirs and the other "free brokerages" spreads in practice so that this can be compared? ## Answer by Kareem Sayed (score 1) https://quant.stackexchange.com/a/64195 Here is a detailed document from a SEC Lawsuit against Robinhood detailing Robinhood's execution practices: Some choice quotes: "For most orders of more than 100 shares, the analysis concluded that Robinhood customers would be better off trading at another broker-dealer because the additional price improvement that such orders would receive at other broker-dealers would likely exceed the approximately \$5 per-order commission costs that those broker-dealers were then charging. The analysis further determined that the larger the order, the more significant the price improvement losses for Robinhood customers—for orders over 500 shares, the average Robinhood customer order lost over \$15 in price improvement compared to Robinhood’s competitors, with that comparative loss rising to more than $23 per order for orders over 2,000 shares." "in 2017, Robinhood developed a proprietary routing algorithm, ... the smart order router did not address Robinhood’s high payment for order flow rates or any potential execution prices that may be available at venues that did not agree to pay those rates. Even with its smart order router, Robinhood customer orders received poor execution quality" There was a semi recent lawsuit against Robinhood that charged them with overcharging customers to the tune of $34.1 million even after taking into account the fact that they dont charge transaction fees. The asset being traded will likely impact the spread. If there is a buyer at 51.5 for AAPL that the Market Maker that Robinhood sells their flow to has access to, they will likely execute at that price. Even if another broker has a buyer at 51.52, your order will exercise at 51.5 or lower. However, AAPL is highly liquid and it is very likely that there are buyers at most prices. A small cap/illiquid securities may have a Robinhood order executing at a far higher price.
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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.