How to find out if your investing app sells your trades to make a profit

Personal Finance Insider writes about products, strategies, and tips to help you make smart decisions with your money. We may receive a small commission from our partners, like American Express, but our reporting and recommendations are always independent and objective.

• Investing apps such as Robinhood direct stock orders to third parties for execution.
• Payment for order flow is the compensation investing apps get in return for routing customer orders.
• PFOF can impact the speed and price of your trades, but not all brokerages use this process.
• Consult with an advisor to make sure you are doing everything to grow your wealth in this challenging time »

Robinhood and several other investing apps recently came under fire for temporarily halting trades of Gamestop (GME) and other stocks. Gamestop’s stock prices hit record highs, due to members of a Reddit forum who worked together to drive up the stock’s value.

But the pause on trades wasn’t the only reason the investment apps were in hot water; the Gamestop incident shined a renewed light on payment for order flow (PFOF), a compensation arrangement used by Robinhood and other apps.

What is payment for order flow (PFOF)?

Payment for order flow is a fee arrangement in which online brokerages and investment apps receive compensation for directing your stock and option orders to third parties. Using PFOF can often result in faster trade execution and improved prices, but it doesn’t always result in the best price for your order — which is why some view it as a conflict of interest. (The brokerage makes money either way.) 

Which apps accept payment for order flow?

Robinhood isn’t the only brokerage that accepts PFOF. Several other investment apps and online brokerages utilize market makers and other third-party sources for order execution. Here’s a look at which investing apps and brokerages accept payment for order flow. 

As shown above, some investment apps that receive PFOF include E*TRADE, Webull, Robinhood, Charles Schwab, and Ally Invest. And Interactive Brokers primarily uses its own order routing system, but it still occasionally earns PFOF from over-the-counter market makers for certain stock orders.

However, some companies — like Fidelity, Merrill Edge and Public — don’t accept payment for order routing.

In fact, though Public has long earned compensation from PFOF, it announced that it plans to replace that stream of income with optional tipping on trades. The company says it’s removing its PFOF compensation model because it misaligns the financial aims of the brokerage and the interests of its clients.

The US Securities and Exchange Commission’s (SEC) Rule 606 requires brokerages to publicly disclose order routing practices via quarterly reports. So if you’re wondering whether your investment app receives this type of compensation, you should be able to find an answer on its website.

How your trades are executed

Not all trades are executed through market makers or high frequency trading firms. Your investment app may route to other parties for best order execution — or it may not accept PFOF at all. This isn’t necessarily a bad thing; Merrill Edge doesn’t accept PFOF and reports on its website that 94.34% of its orders were executed at or better than the quoted security price.

Here are the various options for executing trades:

Market makers: According to investor.gov, market makers are firms that buy and sell exchange-listed stocks at publicly quoted prices. Many market makers also pay online brokerages and investment apps for routing orders to them. In return, the brokerages receive PFOF.

Liquidity providers: Liquidity providers are broker-dealers who strive to get the best order executions, according to Schwab. These providers may also act as market makers or route orders to other trading systems such as Alternative Trading systems.  

Electronic communications network (ECN): Online brokers may also direct your securities orders to ECNs. These networks match your buy and sell orders at certain prices. 

Alternative trading system: ATS execution networks are similar to ECNs since they’re also digital trading systems that automatically match your buy or sell orders. 

Internalization: Instead of routing your orders to a market maker or third-party firm, some brokerages may execute your order internally. This is a common way for investment apps to earn money on the difference between what it paid for the investment and what it sells it to you for, according to investor.gov.

Should you choose an investment app that accepts PFOF?

This is something that only you can answer. If you dislike the business practice of payment for order flow, you may decide to avoid apps that receive it. While brokerages like Robinhood and E*TRADE accept PFOF, some of the top investing apps — including Fidelity  — do not.

Rickie Houston is a wealth-building reporter at Personal Finance Insider who covers investing, brokerage, and wealth-building products.

Disclosure: This post is brought to you by the Personal Finance Insider team. We occasionally highlight financial products and services that can help you make smarter decisions with your money. We do not give investment advice or encourage you to adopt a certain investment strategy. What you decide to do with your money is up to you. If you take action based on one of our recommendations, we get a small share of the revenue from our commerce partners. This does not influence whether we feature a financial product or service. We operate independently from our advertising sales team.

Source: Read Full Article