drew

So if MMs value nontoxic flow, payment for order flow represents *the monetization of that value*. What MMs are paying for is a counterparty that is statistically less likely to adversely select against them on a trade-by-trade basis.

In the highly competitive market of US equities MM, purchasing nontoxic retail flow is a loss reduction technique. So why is that good for a retail trader? The answer here is price improvement.

Essentially, part of the PFOF payment is set aside to give the retail trader a better price than the NBBO.

In the idealized form of this arrangement, the MM, broker, and retail investor all “win”. PFOF results in a tighter spread paid by retail traders for the service of instant liquidity, the brokers get a new revenue stream, and MMs get better, less toxic flow.

So why all the anguish over PFOF? Let's review arguments against such as they are.

the first argument against PFOF cuts directly against the argument for it: the argument is that price improvement figures are overestimated and that retail traders are not getting better prices.

The NBBO putatively represents the best bid and offer price for any given stock, but it turns to not necessarily be the case. Odd lot orders—orders for fewer than 100 shares— placed inside the NBBO are exempt from the NBBO calculation.

In addition, there is dark pool liquidity which is often priced at the NBBO midpoint and also not factored in.