7 ms·

It's a good question. If you are a retail trader, you should almost always use limit orders. You can never get a worse fill than what you ask for but the inte

It's a good question. If you are a retail trader, you should almost always use limit orders. You can never get a worse fill than what you ask for but the internalizer can make money off your order and you can miss out on market moves that occur in the second after you place your order. if you are fine getting price that you put your limit order in for then as far as you are concerned, you'll be fine. As with all things market micro structure related, nanex.net has a good writeup on this. I'm not sure how often this scenario occurs as I've never worked for an internalizer but its http://www.nanex.net/aqck2/What-Every-Retail-Investor-Needs-to-Know.pdf http://www.nanex.net/aqck2/What-Every-Retail-Investor-Needs-... Check out the section called "Marketable Limit Orders". > For example: the Wholesaler receives a retail order to buy 2000 shares at $10.03 or better (lower) when the SIP shows a total of 2000 shares offered at the best offer price of 10.01. 1. Wholesaler buys 300 from one exchange at $10.01, and immediately, 1700 shares that were available on other exchanges disappear, causing the best offer price to move to $10.02. 2. Wholesaler buys 400 at $10.02, and again, sell orders on other exchanges disappear, causing the best offer price to move to $10.03. 3. Wholesaler sells short remaining 1300 shares at $10.0290 to retail investor, providing a $0.0010 price improvement relative to the $10.03 SIP offer price at time of execution. 4. Within seconds, stock reverts back to $10.01 offered. 5. Wholesaler covers short by buying 1300 shares at $10.01. > By quickly influencing the price of the stock, perhaps by less optimal routing, then directly filling the order at an execution price away from the original NBBO at time of Order Receipt, the Wholesaler profits from the $0.019 change on 1300 shares ($24.70), less any "price improvement" given to the retail investor, less the $4.00 Payment for Order flow paid to the Retail Broker (2000 shares x .0020 per share) and $6 in exchange fees (maximum SEC fee $0.0030 per share x 2000 shares).

yummyfajitas 10y ago
This sequence of events is wrong. Here's how it goes: 0. The internalizer tells the brokerage that they want to buy 2000@$10.03. 1. Customer places a buy order 2000@$10.03. 2. Brokerage looks at the internalizer and at the NBBO. Brokerage realizes the NBBO is better than the internalizer and so routes a 700@$10.02 to the public markets as per their legal obligation due to Reg NMS. 3. Brokerage routes the remaining 1300 shares to the internalizer, where they are filled at $10.0290. Customer trades are 300@$10.01, 400@$10.02, 1300@$10.029, resulting in (as you noted) a price improvement to the retail customer. The only this doesn't benefit the customer is if (as kasey_junk notes) the brokerage is using an incorrect NBBO. If you believe a brokerage is doing this please report them to the SEC for violating Reg NMS.
- dguaraglia 10y ago
  Right, so the reason all these banks run extremely expensive HFT divisions is to guarantee the best possible price to their customers. Got it. I'm glad they have our back! /s As someone who has actually seen the scenario described above play out, I'm not so sure: stock doesn't move for minutes at a low volume time of day, the moment I place my limit order the price is suddenly higher than my limit; rinse and repeat. I've seen this happen enough times to make me believe Reg NMS is just another regulation they've found a plausible deniability around (BTW, before you tell me "prices going up when you place a big order is how the market works", I've tested this with 100 share orders, so there was no order split going on. I still got priced out.)
  - kasey_junk 10y ago
    I think everyone is right to be suspicious of payment for order flow, on the surface it does seem hard to get the incentives right. That said, in your scenario (you were prevented from trading) how does anyone make money? You were (probably) paying for a trade (which did not happen) and you were using infrastructure that costs money (placing orders), and no one was able to trade against you. That is not a great business model... Also, none of the groups we are talking about are banks.
    - dguaraglia 10y ago
      My guess is that the algorithm doesn't expect to make money out of that particular order, but rather guesses this is a bigger order that is being split (laddered if you will) into multiple small orders at different acceptable limits. The product I used (Interactive Brokers interface) offers that laddering strategy as an option when trying to make big purchases. Oh, and BTW, order cancellations cost money. Cents, sure, but when you are making money on a 1c spread, you would also benefit from a 1c cancellation. Other than that, I've been tempted (and many times succumbed) to raise the limit just to get that trade. And then you see the price go up again before your order goes through. It'd be hilarious if it wasn't infuriating.
      - 10y ago
jsprogrammer 10y ago
How is step 3 not front running? It would appear to be the very definition; the wholesaler is executing an order before yours, without your knowledge, that will affect your order. Is there an order option to prohibit wholesalers from trading before you?
- cloudjacker 10y ago
  Because the broker isn't doing the front running. That's why it isn't the currently illegal kind of frontrunning. They sell the data to other participants who have faster internet connections than you. Basically any time you send a "smart" routing order, it is actually the least smart thing to do (unless you REALLY need the liquidity). Your trade order gets sent to all the exchanges, and ah I don't really feel like explaining it. tl;dr Someone intercepts your data packet to one exchange, and alters the liquidity on the other exchanges, so you get a partial fill and then adjust your order at the slightly worse price.
  - jsprogrammer 10y ago
    >Because the broker isn't doing the front running. In the scenario presented, the wholesaler receives your order, then executes its own orders, then fills your order based on its own executions (which you are unaware of).
    - tptacek 10y ago
      The wholesaler is required by law to meet or beat the NBBO --- the "exchange price". If you took your tiny order directly to an exchange, you would not fare better.
      - jsprogrammer 10y ago
        The defense is that this behavior is legally sanctioned front running? How can a wholesaler guarantee the exchange price in the face of disappearing orders? I don't think they can. Instead, the wholesaler fabricates an order at the limit of your order, then reports the sale to you. Edit: [rate-limited] Reply to tptacek comment below: > I can't even tell if you're talking about market or limit orders. Can you view the context of this thread? I am talking about the explicit steps listed in the comment I first replied to. Specifically, step 3 [0]. In chollida's description the orders are limit. Step 3 appears to be, exactly, front-running as explained in my post [1] immediately above this one. I asked if anyone could explain how that behavior was not front-running. You responded; indicating that the behavior was according to regulation. You claim that the wholesaler must give you the best "exchange price", but I claim that such a guarantee is generally impossible to fill (time-distance-information problem), and that in the specifics of chollida's described scenario, the wholesaler is actually front-running you by examining your unfilled (limit) order and then filling it at the limit (as in, calculus) with it's own fabricated (perhaps, synthetic, but front-ran, nonetheless) order. If such a guarantee is generally impossible, then the wholesaler must be cheating, the law is incompetent, or, both. [0] https://news.ycombinator.com/item?id=11668835 https://news.ycombinator.com/item?id=11668835 [1] https://news.ycombinator.com/item?id=11669193 https://news.ycombinator.com/item?id=11669193
mrchicity 10y ago
That document is mostly conspiracy nonsense. Wholesalers don't need to push the price around to make money. Most retail trades are tiny, uncorrelated with future order flow, and don't have short-term alpha behind them. The wholesaler will make money filling them at the NBBO with a small improvement and holding the delta. When you can't be hit by hedge funds slicing their massive order into a million pieces, HFT quant algos or arbitrage traders, and don't have to compete to be first in the FIFO queue, making money buying the bid and selling the offer is easy money.
- tptacek 10y ago
  That was my intuitive reaction to that Nanex post as well, but I didn't see how I would handle the rebuttal that doing stuff like Nanex talks about would make internalizers or wholesalers more money.
  - evanpw 10y ago
    Wholesalers have agreements with retail brokers to provide a certain level of "execution quality", and that's what they compete on (fiercely). If they pushed the price around on one order, they'd have to make it up on some other order to meet their obligations. It's measured against NBBO at order receipt time, so chollida1's example would count as negative price improvement (even if the best offer was only showing 100 shares and not 2000).

yummyfajitas 10y ago

This sequence of events is wrong. Here's how it goes: 0. The internalizer tells the brokerage that they want to buy 2000@$10.03. 1. Customer places a buy order 2000@$10.03. 2. Brokerage looks at the internalizer and at the NBBO. Brokerage realizes the NBBO is better than the internalizer and so routes a 700@$10.02 to the public markets as per their legal obligation due to Reg NMS. 3. Brokerage routes the remaining 1300 shares to the internalizer, where they are filled at $10.0290. Customer trades are 300@$10.01, 400@$10.02, 1300@$10.029, resulting in (as you noted) a price improvement to the retail customer. The only this doesn't benefit the customer is if (as kasey_junk notes) the brokerage is using an incorrect NBBO. If you believe a brokerage is doing this please report them to the SEC for violating Reg NMS.

dguaraglia 10y ago
Right, so the reason all these banks run extremely expensive HFT divisions is to guarantee the best possible price to their customers. Got it. I'm glad they have our back! /s As someone who has actually seen the scenario described above play out, I'm not so sure: stock doesn't move for minutes at a low volume time of day, the moment I place my limit order the price is suddenly higher than my limit; rinse and repeat. I've seen this happen enough times to make me believe Reg NMS is just another regulation they've found a plausible deniability around (BTW, before you tell me "prices going up when you place a big order is how the market works", I've tested this with 100 share orders, so there was no order split going on. I still got priced out.)
- kasey_junk 10y ago
  I think everyone is right to be suspicious of payment for order flow, on the surface it does seem hard to get the incentives right. That said, in your scenario (you were prevented from trading) how does anyone make money? You were (probably) paying for a trade (which did not happen) and you were using infrastructure that costs money (placing orders), and no one was able to trade against you. That is not a great business model... Also, none of the groups we are talking about are banks.
  - dguaraglia 10y ago
    My guess is that the algorithm doesn't expect to make money out of that particular order, but rather guesses this is a bigger order that is being split (laddered if you will) into multiple small orders at different acceptable limits. The product I used (Interactive Brokers interface) offers that laddering strategy as an option when trying to make big purchases. Oh, and BTW, order cancellations cost money. Cents, sure, but when you are making money on a 1c spread, you would also benefit from a 1c cancellation. Other than that, I've been tempted (and many times succumbed) to raise the limit just to get that trade. And then you see the price go up again before your order goes through. It'd be hilarious if it wasn't infuriating.
    - 10y ago

jsprogrammer 10y ago

How is step 3 not front running? It would appear to be the very definition; the wholesaler is executing an order before yours, without your knowledge, that will affect your order. Is there an order option to prohibit wholesalers from trading before you?

cloudjacker 10y ago
Because the broker isn't doing the front running. That's why it isn't the currently illegal kind of frontrunning. They sell the data to other participants who have faster internet connections than you. Basically any time you send a "smart" routing order, it is actually the least smart thing to do (unless you REALLY need the liquidity). Your trade order gets sent to all the exchanges, and ah I don't really feel like explaining it. tl;dr Someone intercepts your data packet to one exchange, and alters the liquidity on the other exchanges, so you get a partial fill and then adjust your order at the slightly worse price.
- jsprogrammer 10y ago
  >Because the broker isn't doing the front running. In the scenario presented, the wholesaler receives your order, then executes its own orders, then fills your order based on its own executions (which you are unaware of).
  - tptacek 10y ago
    The wholesaler is required by law to meet or beat the NBBO --- the "exchange price". If you took your tiny order directly to an exchange, you would not fare better.
    - jsprogrammer 10y ago
      The defense is that this behavior is legally sanctioned front running? How can a wholesaler guarantee the exchange price in the face of disappearing orders? I don't think they can. Instead, the wholesaler fabricates an order at the limit of your order, then reports the sale to you. Edit: [rate-limited] Reply to tptacek comment below: > I can't even tell if you're talking about market or limit orders. Can you view the context of this thread? I am talking about the explicit steps listed in the comment I first replied to. Specifically, step 3 [0]. In chollida's description the orders are limit. Step 3 appears to be, exactly, front-running as explained in my post [1] immediately above this one. I asked if anyone could explain how that behavior was not front-running. You responded; indicating that the behavior was according to regulation. You claim that the wholesaler must give you the best "exchange price", but I claim that such a guarantee is generally impossible to fill (time-distance-information problem), and that in the specifics of chollida's described scenario, the wholesaler is actually front-running you by examining your unfilled (limit) order and then filling it at the limit (as in, calculus) with it's own fabricated (perhaps, synthetic, but front-ran, nonetheless) order. If such a guarantee is generally impossible, then the wholesaler must be cheating, the law is incompetent, or, both. [0] https://news.ycombinator.com/item?id=11668835 https://news.ycombinator.com/item?id=11668835 [1] https://news.ycombinator.com/item?id=11669193 https://news.ycombinator.com/item?id=11669193

mrchicity 10y ago

That document is mostly conspiracy nonsense. Wholesalers don't need to push the price around to make money. Most retail trades are tiny, uncorrelated with future order flow, and don't have short-term alpha behind them. The wholesaler will make money filling them at the NBBO with a small improvement and holding the delta. When you can't be hit by hedge funds slicing their massive order into a million pieces, HFT quant algos or arbitrage traders, and don't have to compete to be first in the FIFO queue, making money buying the bid and selling the offer is easy money.

tptacek 10y ago
That was my intuitive reaction to that Nanex post as well, but I didn't see how I would handle the rebuttal that doing stuff like Nanex talks about would make internalizers or wholesalers more money.
- evanpw 10y ago
  Wholesalers have agreements with retail brokers to provide a certain level of "execution quality", and that's what they compete on (fiercely). If they pushed the price around on one order, they'd have to make it up on some other order to meet their obligations. It's measured against NBBO at order receipt time, so chollida1's example would count as negative price improvement (even if the best offer was only showing 100 shares and not 2000).