1. Brokers don't only send orders to 3rd party market makers because they're being paid for order flow. You're right, they won't get order flow for free, but I didn't mean to imply that they did.
2. Quoting and buying at their published bid/ask is precisely their function. Possibly we're just disagreeing on terms. The SEC's website is fairly good at explaining this flow. http://www.sec.gov/investor/pubs/tradexec.htm
3. What I'm discussing is the actual mechanism for HOW nbbo is fulfilled. Competition in the marketplace -- third party market makers and arb firms -- absolutely play a role in ensuring the efficiency of the market. If brokers had to run this infrastructure themselves, it would be non-trivial and without any financial incentives that I can think of.
I think he was making a little joke about this. He said:
fill my buy orders at the bid
and sell orders at the ask
Of course, that wasn't what you originally said, which was
a firm who agrees to buy at the bid
and sell at the ask
[1] http://en.wikipedia.org/wiki/Knight_Capital_Group#2012_stock...
> In most cases your order will get routed to a 3rd party liquidity provider,
This is only true if you are a regular person, ie using IB to buy in your rrsp or ira account. Almost exclusively, anyone who is a professional will go direct to market( DMA). They will never go through Citadel or some other liquidity provider.
> Often, these guys will pay the broker for order flow
Not often, always. They always pay for this, there are no freebies:)
> a firm who agrees to buy at the bid and sell at the ask and do so quickly.
If you can find someone who will guarentee that they will fill my buy orders at the bid and sell orders at the ask, please let me know and I'll give them all my flow:)
> Competition between these firms goes a long way towards guaranteeing the NBBO price that your broker is obligated to provide.
What does this even mean, even without someone buying your flow you are still guaranteed to get the NBBO price, RegNMS says this is the law. Let me be clear, 3rd party brokers have no part in guaranteeing you get the NBBO price. The law says if your order can trade at the NBBO, it must.