For example, if you buy a stock on no-fee Schwab, you place an order. The brokerage sends that buy order — say, for $5 — to a third party. That entity sells you the stock for $5, but the actual cost of it was $4.99. The $0.01 made on that trade is then shared between the third party and the broker.
For example, an outside professional trading firm may buy up all the retail-investor orders that come from a broker, be it Robinhood or Fidelity, and executes those trades.
These companies then make money from the gap between the bid and the offer. And depending on whatever they make, the broker then receives payment for the order flow.
“When a company offers something for free… online brokers still make money from you in other ways,” said Investopedia Editor-in-Chief Caleb Silver. “There is no real free lunch.”
The aggressive moves by Schwab and Ameritrade raise questions about how Robinhood will protect its competitive advantage. Given the startup’s heavy millennial user demographic, there’s a question about whether bigger brokers will suddenly become more popular among younger investors.
“The changes taking place across the brokerage industry reflect a focus on the customer that‘s been inherent to Robinhood since the beginning,” said Jack Randall, a spokesperson Robinhood.