How Zero-Commission Trading Changed the Industry
The brokerage industry underwent a seismic shift when major retail brokers began eliminating trading commissions on stocks and ETFs. What once seemed like a competitive differentiator quickly became an industry standard, fundamentally altering how retail brokers generate revenue and how investors think about the cost of trading.
But "free" trading is rarely truly free. Understanding the business models behind zero-commission platforms is essential for any informed investor.
The Business Model Behind "Free" Trades
Brokers who charge no commissions still need to generate revenue. The primary mechanism many use is called Payment for Order Flow (PFOF). Here's how it works:
- When you place a trade on a zero-commission platform, your order is routed to a market maker rather than directly to an exchange.
- The market maker pays the broker a small fee for that order flow.
- The market maker profits by executing your trade at a slightly less favourable price than the best available market price — a cost known as the "spread."
The difference in price is typically tiny for individual trades, but across millions of transactions it amounts to significant revenue for the market maker — and by extension, the broker.
Is Payment for Order Flow a Problem?
PFOF has become a contentious topic among regulators and market participants. The concerns are:
- Conflict of interest – Brokers may route orders based on the highest payment received rather than the best execution price for the client.
- Price quality – Retail investors may not receive the best available price in the market.
- Transparency – The mechanics are opaque to most retail investors.
The UK's FCA has effectively banned PFOF, and the EU has moved to restrict it under MiFID II reforms. The US SEC has reviewed the practice extensively, though a formal ban has not been enacted at the time of writing.
Other Revenue Streams for Zero-Commission Brokers
Beyond PFOF, no-commission brokers may earn revenue through:
- Interest on uninvested cash – Brokers often earn the spread between the interest paid on client cash balances and what they earn by lending it out.
- Margin lending – Charging interest when clients trade on borrowed money.
- Premium subscriptions – Offering advanced tools, research, or features for a monthly fee.
- Foreign exchange fees – Applying a markup when converting currencies for international trades.
What This Means for You as an Investor
The proliferation of zero-commission trading is genuinely positive for long-term, buy-and-hold investors. Eliminating per-trade fees makes regular investing more accessible and cost-effective, particularly for those making small, frequent contributions.
However, active traders executing many trades per day should pay attention to execution quality, not just headline commission rates. A slightly worse fill price on every trade can outweigh the savings from zero commissions.
Questions to Ask Before Using a Zero-Commission Broker
- Does the broker use PFOF, and is that disclosed clearly?
- What interest rate is paid on uninvested cash balances?
- Are there fees for options, international trades, or account transfers?
- How does the broker's execution quality compare to competitors?
The Bigger Picture
Zero-commission trading has democratised market access in meaningful ways — and that's largely a good thing. But as with any product described as "free," it pays to understand the underlying economics. Knowing how your broker makes money helps you identify where your interests may or may not align.