What really happens when we offer to buy or sell a stock?

We buy stock in an app, our order is matched with a seller on an exchange, like on Nasdaq, and we become shareholders, right?

Well, actually that’s usually not what happens.

Instead, if we put in an order on an app to buy a share at the market price, it’s more likely that our broker sends our order to what’s often called a wholesaler, in the dark market. 

The wholesaler might be paying the broker for the right to execute the order. That’s what’s called payment for order flow. 

It’s probably obvious why the app would take this payment, but we may wonder why a wholesaler is willing to pay to trade with us. When we buy or sell a stock, our broker is required to provide us “best execution.” We’re supposed to get the best price reasonably available. Not just a good price. 

If one of our market orders to buy stock were routed to an exchange, the exchange would need to match our order with the lowest price available on that exchange. That’s called competition — our orders compete against each other to get the best prices.

But if the order instead is routed to a wholesaler that has agreed to pay for it, the order is not going to an exchange and is not necessarily receiving the benefit of that broader competition. 

The wholesaler might sell to us at a price better than the best price shown to the public on the exchange, but not necessarily the best price available. 

You see, that’s because so much of the market is in the dark pools or with the wholesalers in dark, not necessarily competing order by order.

These payments, the payment for order flow, thus can create conflicts of interest. 

When the broker’s app encourages us to trade, was the broker acting in our best interest or trying to generate more payments from our transactions? 

Look, some brokers will say that these payments allow them to charge zero commissions, but there’s no such thing as free lunch. There’s still cost. We just don’t necessarily see it directly. 

Our markets should always be working for us, not just the big actors and the big financial players.  

See video