4 ms·

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 orde

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.
    - tptacek 10y ago
      Just chiming in to point out that 'yummyfajitas, 'chollida1, and 'kasey_junk are all current or former trading engineers.
      - dguaraglia 10y ago
        I imagined as much. That's what I love about HN, you do get some details on how the sausage is made from the sausage-makers themselves.
    - yummyfajitas 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. If the order is coming from a retail brokerage that's a terrible guess - how often do you think someone goes into ETrade and tries to move $20M of GOOG? Big orders come from institutional investors. Those are explicitly the orders that market makers are trying NOT to trade against, and that's why they try to buy order flow. Order flow is known to come from players who aren't making big orders.
      - dguaraglia 10y ago
- yummyfajitas 10y ago
  They don't. They run them to make a profit off the spread. The purpose of order internalization is to trade against uninformed participants (Joe 401k), without risk of accidentally trading against bigger informed players (Bill Ackman). If you are trading against uninformed players, your risk is lower and you need to offer a better price to get order flow. Read these two blog posts for a bit more detail on price discrimination on the basis of delta toxicity (albeit not in the order internalization context). https://www.chrisstucchio.com/blog/2014/fervent_defense_of_frontrunning_hfts.html https://www.chrisstucchio.com/blog/2014/fervent_defense_of_f... https://www.chrisstucchio.com/blog/2014/mark_cubans_hft_idiocy.html https://www.chrisstucchio.com/blog/2014/mark_cubans_hft_idio... If you want to argue that something nefarious is going on, go ahead and describe the mechanism. But whatever it is, it's almost certainly not the mechanism chollida described.
  - dguaraglia 10y ago
    I have no idea what the mechanism is, but there's definitely something extremely fishy when you don't see the NBBO move at all for an hour and it magically moves the moment you place an order. I wouldn't even know who is to blame: Interactive Brokers? Other HFT players? My incredibly consistent bad luck at placing an order at the exact same moment the price goes up, even after observing the price being stable for an hour (again, at a very low volume time of day, like 3pm PST)? I clearly don't understand what's going on under the table as well as you would, and because the strategy I was toying around with at the time was basically big volume on small spreads ("big" for a retail guy, obviously, I don't have millions at my disposal) it was shot to crap by these magic changes. So I did the sensible thing and closed my account. Off to invest in less volatile assets, if I can find any, heh.

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.
  - tptacek 10y ago
    Just chiming in to point out that 'yummyfajitas, 'chollida1, and 'kasey_junk are all current or former trading engineers.
    - dguaraglia 10y ago
      I imagined as much. That's what I love about HN, you do get some details on how the sausage is made from the sausage-makers themselves.
  - yummyfajitas 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. If the order is coming from a retail brokerage that's a terrible guess - how often do you think someone goes into ETrade and tries to move $20M of GOOG? Big orders come from institutional investors. Those are explicitly the orders that market makers are trying NOT to trade against, and that's why they try to buy order flow. Order flow is known to come from players who aren't making big orders.
    - dguaraglia 10y ago
yummyfajitas 10y ago
They don't. They run them to make a profit off the spread. The purpose of order internalization is to trade against uninformed participants (Joe 401k), without risk of accidentally trading against bigger informed players (Bill Ackman). If you are trading against uninformed players, your risk is lower and you need to offer a better price to get order flow. Read these two blog posts for a bit more detail on price discrimination on the basis of delta toxicity (albeit not in the order internalization context). https://www.chrisstucchio.com/blog/2014/fervent_defense_of_frontrunning_hfts.html https://www.chrisstucchio.com/blog/2014/fervent_defense_of_f... https://www.chrisstucchio.com/blog/2014/mark_cubans_hft_idiocy.html https://www.chrisstucchio.com/blog/2014/mark_cubans_hft_idio... If you want to argue that something nefarious is going on, go ahead and describe the mechanism. But whatever it is, it's almost certainly not the mechanism chollida described.
- dguaraglia 10y ago
  I have no idea what the mechanism is, but there's definitely something extremely fishy when you don't see the NBBO move at all for an hour and it magically moves the moment you place an order. I wouldn't even know who is to blame: Interactive Brokers? Other HFT players? My incredibly consistent bad luck at placing an order at the exact same moment the price goes up, even after observing the price being stable for an hour (again, at a very low volume time of day, like 3pm PST)? I clearly don't understand what's going on under the table as well as you would, and because the strategy I was toying around with at the time was basically big volume on small spreads ("big" for a retail guy, obviously, I don't have millions at my disposal) it was shot to crap by these magic changes. So I did the sensible thing and closed my account. Off to invest in less volatile assets, if I can find any, heh.