Payment for Order Flow and Best Execution on Lit Stock Markets
Summary
The discussion asks whether payment for order flow can affect trades on non-OTC stock markets when brokers have a duty to seek best execution. It explains that best execution does not guarantee the best displayed price for every order. Delays in price data or order routing, mobile limit-order transmission, and odd-lot handling can affect the price a customer receives.
The answers also describe how some orders may be filled away from a lit exchange. A market maker can execute an order at a price slightly better than the national best bid or offer, while still earning from the order flow. The explanation illustrates why a marginal price improvement does not by itself establish that the customer received the best available outcome. The discussion is conceptual and gives no measured comparison of execution quality or detailed regulatory analysis; its claims should not be treated as a complete account of how all brokers or venues operate.
Key ideas
- Best execution does not ensure that every trade receives the best displayed price.
- Delays in quotes and order transmission can affect execution quality.
- Some orders may be filled by dealers away from lit exchanges.
- A dealer can provide a small price improvement and still benefit from receiving the order flow.
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Full text
# Does payment for order flow happen on non-OTC stock markets? # Does payment for order flow happen on non-OTC stock markets? I thought since brokers on non-OTC market have obligation to get its customers best execution price, it’s meaningless for dealers(market maker) to pay brokers for the order flow for dealers to make “spread profit” from. Because even if a dealer pays brokers for the order flow, if he isn’t the one quoting the best prices, he won’t get the orders anyway. Isn’t it true? ## Answer by tom (score 1) https://quant.stackexchange.com/a/69957 Best execution does not mean best execution on every trade. In addition delays and weaknesses in calculating the NBBO (National Best Bid and Offer), delays in transmission speeds for limit orders from mobile aps and execution rules for odd-lot trades all impact execution to the detriment of the investor. Read below one simple example of why your statement above is incorrect https://www.marketwatch.com/story/commission-free-stock-market-trading-on-some-platforms-may-be-raising-costs-and-volatility-for-all-of-us-11645017928 ## Answer by Brian B (score 0) https://quant.stackexchange.com/a/79988 When payment for order flow happens, a proportion of the orders never make it to any market, OTC or "lit". As @tom (upvoted) says, "best" execution can have more than one meeting. From a regulatory point of view, Citadel and Virtu are in the clear when they fill incoming buy orders at prices less than the national best offer (and vice versa for sell orders). So, when they think an order is "juicy", they fill it at a price a fraction of a penny better than the national best.
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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.