What is a payment for order flow (PFOF)?
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When you buy or sell stocks you are almost never transacting with another person but instead a type of bank known as a market maker. Market makers do just that, they guarantee a market by always being willing to buy or sell a security. They don’t make money on the actual security going up or down in value but rather through the bid ask spread. So if stock ABC has a bid of $10 and an ask of $11 this means the MM will sell a stock to you for $11 and buy for $10, collecting the $1 difference. For any liquid security this spread is going to be closer to a penny.
Now when you tell your brokerage to buy or sell a stock they are obligated to get you the best price available. So if you put in a buy order for stock ABC and there are multiple sellers your brokerage has to go with the best price. If there are multiple sellers with the same price and that is the best price available then your broker can route the order to a specific MM in exchange for a kickback. This is basically what payment for order flow is.
PFOF is also a large part of why there are $0 trading fees today. Not even 10 years ago $5 per trade was seen as a cheap price.
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