No commission deals - no free lunch

One of Wall Street's biggest stories lately is the wave of online brokers who have eliminated their commissions for trading stocks and ETFs.

Interactive Brokers, Charles Schwab Corporation, TD Ameritrade Holding Corp. and E * TRADE Financial Corp are among the group that cut their commissions to zero and their shares have collapsed as a result.

But just because traders no longer pay transaction fees does not mean that brokers do not receive money.

There is no free lunch.

Now more than anything, brokers will rely on Pay for Order Flow (PFOF)

Market makers pay their retail brokers the privilege of having their clients receive orders first. The market maker will execute directly against the retail order (if they believe they can make money from it). Simply put, they pay for the privilege of trading first for dumb money.

Retail brokers can also collect liquidity discounts that are paid from public exchanges.

In some cases, these discounts are .003 / share, which means that a $ 1,000 share order will be $ 3 profit for the broker.

Order Flow is the new game for online brokers.

These orders will never reach the public market because they are met by market makers. This limits the diversification of the flow of orders and can disrupt the price discovery process.

And as brokerage stocks plunged last week, Morgan Stanley commented that Virtu Financial Inc. may be a disguised winner.

"It is very likely that we will see an increase in trading activity due to zero commissions, which will result in more orders, just like VIRT, which are market makers and earn from a large volume of activity," MS commented.

Wells Fargo downgraded the companies in this group, saying that the combination of slowing organic revenue growth, falling interest rates and disappearing commission income would continue to weigh on stocks.

And while Virtu may be the short-term winner, this collapse of brokerage stocks can create a good opportunity for long-term investment. But while companies prove they can successfully replace lost commission profits with PFOF, buying the dip is a very risky move.

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