Why it’s not so simple when you hit the trade button (part 3)

Interview with an order flow manager

By Franklin Gold

The final part of my interview with Jay Owen, former order flow manager for Fidelity Investments. For Part 1, click here or for Part 2, click here.

Franklin - Let’s get to the hot topic of the day in order handling – payment for order flow (PFOF). First, can you give us a quick definition? How do brokerage firms get paid for directing their order flow?

Jay – The simplest definition of PFOF is that it’s a way that trading venues can share their profits with brokers sending orders their way.

There are different ways that payments to brokers can be calculated. They can be at a certain rate per executed share or a percentage of the quoted bid/ask spread. The payments can vary depending on the characteristics of the orders. Payments for equity and options trades differ widely, typically with much higher payments for options trades.

Market and marketable limit orders are handled differently than non-marketable limit orders. Brokers handling non-marketable limit orders have a display obligation (for round lots) so they route those orders to a registered exchange which will display their order publicly. Brokers may get paid for these orders by the exchanges under various maker/taker pricing schemes.

Odd lots, currently less than 100 shares, still have to be filled at the market or better, but there’s no obligation to display them publicly.

Finally, remember that PFOF is about trading venues sharing their profits with brokers. Any funds paid to the broker are funds that won’t be available to improve the price paid to customers.

Franklin - Can retail customers use 605 / 606 reports in choosing a brokerage firm?

Jay – It’s difficult for retail customers to use this data effectively. All the brokers are using the same firms / exchanges for trading. How much each broker is being paid by the different trading venues can certainly give a customer some insight. But given that customers from different firms trade different stocks at different times in varying order sizes and order types, you can’t really extrapolate to what you as a customer may trade to the data shown on these reports.

The Financial Information Forum (FIF) attempted to promote transparency with standardized and enhanced retail execution quality disclosures. The broker-dealers would voluntarily publish these standardized statistics. Only a few FIF members agreed to publish these reports on their websites.

The most important caveat – don’t depend on data brokers are showing on their web sites. Some of them cherry pick their numbers to show off one or two areas where they excel. There’s also no consistency in that information across brokers so you can’t use it for comparison purposes. it doesn’t really help you make a decision.

Franklin – Thanks for a great conversation Jay.

Jay – Your welcome. Hopefully, this will be helpful to investors when they’re searching for a broker.