6 ms·

Can you extrapolate on order flow from unsophisticated investors? Why is it valuable?

drzaiusapelord 9y ago
Lets say you're unsophisticated. You say "I like my 1080ti, so I'll buy some NVIDIA stock." I'm a tech stock expert, I know NVIDIA is on a downward slope because its over-valued right now. I tell you "Sure kid, here's a promise for 100 shares at today's price of $50 each." I take your $5,000. Everyone is happy. Joe Investor doesn't actually have the stock in his possession just yet. I buy the stock myself a few days later, but at $40 each for a grand total of $4,000, and I just made $1,000. You get your 100 shares, I make $1,000 plus fees. Now imagine doing this hundreds or thousands of times a day. Or I simply sell my own existing supply conveniently to my own buyer and I dictate the fees, which has value in itself. Sure I'm only making $5 per head per month with these low-end customers, but now I have 100,000 customers instead of 1,000. A savvy investor wouldn't ask to buy these shares. He'd know that he's better off shorting himself. Unsavvy investors are all over the place and if you can get them to come to you, you can make a lot of money off them with minimal investment or risk. On top of that you can offer them predatory loans for investing. This app offers loans, no idea on terms, but I can't imagine them being very nice. They put up collateral like their car or home, so you have no risk. They fuck up, or not, it doesn't matter, you're at least getting fees and probably screwing them in other ways. Oh and you're getting interest on that loan as well. edit: Front Loading absolutely happens, it can be done in a way that's difficult or impossible to detect and has a lot of loopholes as well.
- brianwawok 9y ago
  Well, I don't think this is a legal use of order flow (waiting days to make a purchase), but the analogy is kinda sorta on the right path. Reality is more like "I know an order for NVIDIA is going to hit at $50, but I see it for sale for 49.9998 all over the place, I can go scoop some up at 49.9998 and put for sale at 49.9999 and make some money. But then real reality is a step more complicated about when it is legal to do this vs not (front running is not legal, but things that are similar can be), and dark pool vs not, and you are way past what I know ;)
  - jnordwick 9y ago
    Front running would be going the same direction (buy for buy). In buying order flow, you are usually going in the opposite direction, selling out of you own inventory against a buy.
    - brianwawok 9y ago
      There you go :)
  - appetizer 9y ago
    not illegal use of order flow
- jnordwick 9y ago
  HK articles on finance sadden me. So much bad information. The firm isn't buying days later after a price craters. They are usually buying or selling out of their own inventory. Sometimes this is speculative trades, more often it is more mundane like saving transaction fees (and a higher certainty of transacting) from going to the market.
omarforgotpwd 9y ago
In the London stock market they used to have a game where traders got a stack of pictures of girls, and had to rate each picture based on what they thought the average rating for each picture would be from everyone else. This essentially captures what stock trading is. It's not just about figuring out which company is the "prettiest girl" on the market, you have to be able to predict which girl everyone else is going to think is pretty in the future, because stock prices rise when a lot of people want to buy that stock and few people want to sell. Order book data is valuable because it helps you figure out who everyone thinks is pretty, and retail investors make these decisions on much different factors than traders (I.e. Brand over financials)
- dsacco 9y ago
  More succinctly: it is a Keynesian beauty contest. https://en.wikipedia.org/wiki/Keynesian_beauty_contest https://en.wikipedia.org/wiki/Keynesian_beauty_contest
candiodari 9y ago
Because when you buy shares on a platform you don't buy them yourself. You don't have an account at the exchange. The brokerage buys them on their account. So let's calculate the fees. For a given stock, FCKD, the bid offer is $4.50, the lowest offer is $4.60. Transaction costs for this are $0.10 at the brokerage. Investor A wants to buy a share, B wants to sell one, on the same brokerage. Okay let's see. Brokerage does nothing (because the amount of shares they hold on the exchange for their clients doesn't change at all). So they don't pay anything for that either. No transaction fees, nothing. A gets to buy the share, and has to pay the lowest offer + transaction costs for the share, or $4.70. B wants to sell the share, and he gets to sell if for the highest bid, or $4.50, and in some cases another $0.10 in transaction costs. So the brokerage "captures the spread", and of course the transaction costs. In this case they made $0.40 for doing ... nothing, no share was sold or bought. This is the official story. Now in practice, this means that a rather large amount of value is "stored" at the brokerage. It is a long accepted practice in banking that only a percentage of the stored value is kept. So while you might think that as a result of this transaction the bank/brokerage makes $0.40 in profit, but it doesn't. Assuming 10% reserve ratio (which is on the high end, usually either 2 or 4%). It makes (100% - 10%) * 2 * $4.55 + $0.40, and pays that out to it's shareholders/managers/... (twice, because once in cash, one in a share) Now you might think that's where it stops. Well, not quite. They then go to another bank, and they say "we are holding an asset worth $X on behalf of our customers, can we borrow against that ?", and the next bank say "sure ! if we can do the same". So bank A gets a 2 * $4.55 debt at bank B, and bank B gets a 2 * $4.55 debt at bank A. Since this also counts as reserves, they then only keep 10% of that money actually available, and pay 90% out to their shareholders. So now the bank has paid out (100% - 10%) * 6 * $4.55 + $0.40 to it's shareholders. Needless to say, keeping this whole situation stable if the market were to gasp drop even slightly is more than a little tricky. Hence, "too big to fail". That's why you want to be a bank. This is the reserve currency system we currently work with.
- jnordwick 9y ago
  None of this makes any sense: Where did you get this information? You should ask for your money back: >(100% - 10%) * 2 * $4.55 + $0.40, and pays that out to it's shareholders/managers >(twice, because once in cash, one in a share) >can we borrow against that ?", and the next bank say "sure ! if we can do the same > Since this also counts as reserves > pay 90% out to their shareholders. > if the market were to gasp drop even slightly > Assuming 10% reserve ratio (which is on the high end, usually either 2 or 4%)
harryh 9y ago
It has to do with how people/companies called "market makers" make money. Let's say you want to buy a share of stock. Generally you don't end up buying it from another random person who happens to want to sell a share of stock at the exact same time. There might not even be another random person that wants to sell right now. Instead you are likely buying from a market maker. For pretty much any stock there are many market makers who are offering to both buy stock and sell it at the same time. The trick is they'll buy for, say, a penny less than they are willing to sell for. So if they can keep their buys/sells even they make a penny for every share they move. They're middle men. Make sense so far? OK, but there is a problem. Say that REALLY BIG HEDGE FUND has proprietary knowledge that some company is probably going to go up in value soon. So they go out and buy a lot of stock from a market maker. And then the stock goes up. Uh oh. The market maker sold a bunch of stock at PRICE and now instead of buying an equal amount at (PRICE - 1 penny) and making money the market maker has to buy an equal amount at (PRICE + the_stock_went_up_amt) and loses money. Basically market makers would prefer not to trade with sophisticated investors making big trades with proprietary knowledge. When that happens and they lose it's called getting picked off. They want to trade with people like you and me who aren't trading because of any special knowledge but because we're just putting our regular $1,000 in our 401k for the month. Retail brokerages like Robinhood are a good source of these types of trades. (As with a lot of topics, there is a lot of nuance and detail underneath this relatively short description, but this is the gist of it.)
- metalliqaz 9y ago
  Great explanation, thank you.
- kasey_junk 9y ago
  It's worth noting that "sophistication" is not really the defining characteristic that makes retail order flow appealing, it's that it's non-correlated with other market events. Retail flow is driven by things like needing money for purchases or having excess cash lying around. Also retail flow is less execution cost sensitive. That's what people mean when they say less sophisticated.
  - 9y ago

Lets say you're unsophisticated. You say "I like my 1080ti, so I'll buy some NVIDIA stock." I'm a tech stock expert, I know NVIDIA is on a downward slope because its over-valued right now. I tell you "Sure kid, here's a promise for 100 shares at today's price of $50 each." I take your $5,000. Everyone is happy. Joe Investor doesn't actually have the stock in his possession just yet. I buy the stock myself a few days later, but at $40 each for a grand total of $4,000, and I just made $1,000. You get your 100 shares, I make $1,000 plus fees. Now imagine doing this hundreds or thousands of times a day. Or I simply sell my own existing supply conveniently to my own buyer and I dictate the fees, which has value in itself. Sure I'm only making $5 per head per month with these low-end customers, but now I have 100,000 customers instead of 1,000. A savvy investor wouldn't ask to buy these shares. He'd know that he's better off shorting himself. Unsavvy investors are all over the place and if you can get them to come to you, you can make a lot of money off them with minimal investment or risk. On top of that you can offer them predatory loans for investing. This app offers loans, no idea on terms, but I can't imagine them being very nice. They put up collateral like their car or home, so you have no risk. They fuck up, or not, it doesn't matter, you're at least getting fees and probably screwing them in other ways. Oh and you're getting interest on that loan as well. edit: Front Loading absolutely happens, it can be done in a way that's difficult or impossible to detect and has a lot of loopholes as well.

brianwawok 9y ago
Well, I don't think this is a legal use of order flow (waiting days to make a purchase), but the analogy is kinda sorta on the right path. Reality is more like "I know an order for NVIDIA is going to hit at $50, but I see it for sale for 49.9998 all over the place, I can go scoop some up at 49.9998 and put for sale at 49.9999 and make some money. But then real reality is a step more complicated about when it is legal to do this vs not (front running is not legal, but things that are similar can be), and dark pool vs not, and you are way past what I know ;)
- jnordwick 9y ago
  Front running would be going the same direction (buy for buy). In buying order flow, you are usually going in the opposite direction, selling out of you own inventory against a buy.
  - brianwawok 9y ago
    There you go :)
- appetizer 9y ago
  not illegal use of order flow
jnordwick 9y ago
HK articles on finance sadden me. So much bad information. The firm isn't buying days later after a price craters. They are usually buying or selling out of their own inventory. Sometimes this is speculative trades, more often it is more mundane like saving transaction fees (and a higher certainty of transacting) from going to the market.

omarforgotpwd 9y ago

In the London stock market they used to have a game where traders got a stack of pictures of girls, and had to rate each picture based on what they thought the average rating for each picture would be from everyone else. This essentially captures what stock trading is. It's not just about figuring out which company is the "prettiest girl" on the market, you have to be able to predict which girl everyone else is going to think is pretty in the future, because stock prices rise when a lot of people want to buy that stock and few people want to sell. Order book data is valuable because it helps you figure out who everyone thinks is pretty, and retail investors make these decisions on much different factors than traders (I.e. Brand over financials)

dsacco 9y ago
More succinctly: it is a Keynesian beauty contest. https://en.wikipedia.org/wiki/Keynesian_beauty_contest https://en.wikipedia.org/wiki/Keynesian_beauty_contest

candiodari 9y ago

Because when you buy shares on a platform you don't buy them yourself. You don't have an account at the exchange. The brokerage buys them on their account. So let's calculate the fees. For a given stock, FCKD, the bid offer is $4.50, the lowest offer is $4.60. Transaction costs for this are $0.10 at the brokerage. Investor A wants to buy a share, B wants to sell one, on the same brokerage. Okay let's see. Brokerage does nothing (because the amount of shares they hold on the exchange for their clients doesn't change at all). So they don't pay anything for that either. No transaction fees, nothing. A gets to buy the share, and has to pay the lowest offer + transaction costs for the share, or $4.70. B wants to sell the share, and he gets to sell if for the highest bid, or $4.50, and in some cases another $0.10 in transaction costs. So the brokerage "captures the spread", and of course the transaction costs. In this case they made $0.40 for doing ... nothing, no share was sold or bought. This is the official story. Now in practice, this means that a rather large amount of value is "stored" at the brokerage. It is a long accepted practice in banking that only a percentage of the stored value is kept. So while you might think that as a result of this transaction the bank/brokerage makes $0.40 in profit, but it doesn't. Assuming 10% reserve ratio (which is on the high end, usually either 2 or 4%). It makes (100% - 10%) * 2 * $4.55 + $0.40, and pays that out to it's shareholders/managers/... (twice, because once in cash, one in a share) Now you might think that's where it stops. Well, not quite. They then go to another bank, and they say "we are holding an asset worth $X on behalf of our customers, can we borrow against that ?", and the next bank say "sure ! if we can do the same". So bank A gets a 2 * $4.55 debt at bank B, and bank B gets a 2 * $4.55 debt at bank A. Since this also counts as reserves, they then only keep 10% of that money actually available, and pay 90% out to their shareholders. So now the bank has paid out (100% - 10%) * 6 * $4.55 + $0.40 to it's shareholders. Needless to say, keeping this whole situation stable if the market were to gasp drop even slightly is more than a little tricky. Hence, "too big to fail". That's why you want to be a bank. This is the reserve currency system we currently work with.

jnordwick 9y ago
None of this makes any sense: Where did you get this information? You should ask for your money back: >(100% - 10%) * 2 * $4.55 + $0.40, and pays that out to it's shareholders/managers >(twice, because once in cash, one in a share) >can we borrow against that ?", and the next bank say "sure ! if we can do the same > Since this also counts as reserves > pay 90% out to their shareholders. > if the market were to gasp drop even slightly > Assuming 10% reserve ratio (which is on the high end, usually either 2 or 4%)

harryh 9y ago

It has to do with how people/companies called "market makers" make money. Let's say you want to buy a share of stock. Generally you don't end up buying it from another random person who happens to want to sell a share of stock at the exact same time. There might not even be another random person that wants to sell right now. Instead you are likely buying from a market maker. For pretty much any stock there are many market makers who are offering to both buy stock and sell it at the same time. The trick is they'll buy for, say, a penny less than they are willing to sell for. So if they can keep their buys/sells even they make a penny for every share they move. They're middle men. Make sense so far? OK, but there is a problem. Say that REALLY BIG HEDGE FUND has proprietary knowledge that some company is probably going to go up in value soon. So they go out and buy a lot of stock from a market maker. And then the stock goes up. Uh oh. The market maker sold a bunch of stock at PRICE and now instead of buying an equal amount at (PRICE - 1 penny) and making money the market maker has to buy an equal amount at (PRICE + the_stock_went_up_amt) and loses money. Basically market makers would prefer not to trade with sophisticated investors making big trades with proprietary knowledge. When that happens and they lose it's called getting picked off. They want to trade with people like you and me who aren't trading because of any special knowledge but because we're just putting our regular $1,000 in our 401k for the month. Retail brokerages like Robinhood are a good source of these types of trades. (As with a lot of topics, there is a lot of nuance and detail underneath this relatively short description, but this is the gist of it.)

metalliqaz 9y ago
Great explanation, thank you.
kasey_junk 9y ago
It's worth noting that "sophistication" is not really the defining characteristic that makes retail order flow appealing, it's that it's non-correlated with other market events. Retail flow is driven by things like needing money for purchases or having excess cash lying around. Also retail flow is less execution cost sensitive. That's what people mean when they say less sophisticated.
- 9y ago