6 ms·

Mom and pop investors are on a stock buying spree, fueled by free trades

40 points by ilamont 7y ago

yellow_lead 7y ago
As others have pointed out, these "free trades" aren't actually free. In exchange, you lose good order execution. Brokerages like Robinhood seem to outsource this to other market makers which in turn give them a kickback for sending those orders their way.
- phyek 7y ago
  The average "mom and pop" investor can give 2 craps about trade execution. An execution price with a 20bps delta is MEANINGLESS to them.
  - yellow_lead 7y ago
    I don't mean to imply that it's meaningful to them, but I think it's meaningful for this audience.
  - Mountain_Skies 7y ago
    A friend was trying to convince me that high frequency trading was a good thing because of the liquidity it added to the market would allow me to sell my stock in milliseconds. If I've been holding a stock for twenty years, when I go to sell it, do I really care if it takes twenty minutes instead of twenty milliseconds? From the look on his face it was obvious that in his world investing in stocks long term is completely alien. Can't be too hard on him though, he did warn me of the Great Recession months in advance, with problems he was seeing in credit default swap pricing being what he considered the Archduke Ferdinand of the financial system.
    - perl4ever 7y ago
      "do I really care if it takes twenty minutes instead of twenty milliseconds?" No, nobody sensible cares. But the stuff people are suspicious of is supposed to be regulated so that your executions are only improved. If somehow this isn't true, it should be a bright line crossed and a big scandal with people going to jail or at least big fines. Then again, if you panic over a "flash crash", then I guess you should be concerned about liquidity?
    - yellow_lead 7y ago
      > If I've been holding a stock for twenty years, when I go to sell it, do I really care if it takes twenty minutes instead of twenty milliseconds? I think you may care actually. To give an example, I was holding a stock for several years that recently went up in price quickly, without much change in the underlying business. Simply, analysts started changing their rating on it. When this stock got high enough, I started to feel nervous, and I was watching the market open on a day when I was prepared to sell. Immediately, the stock started to tank, and I sold it right away. I sold it at a good price, and even though I was a long term investor, I made a short term decision to sell based off the (IMO) extremely irrational price.
- dehrmann 7y ago
  Where can one find better order execution? Citation needed, but I read the market makers buying these orders tend to get investors prices better than the bid-ask spread, so it's still good for retail investors. And it's not like it's any worse than when it was $10 per trade.
  - yellow_lead 7y ago
    It's subjective but I'll recommend Interactive Brokers. Their trades cost $1. You can also go to a big brokerage like Goldman or Schwab and probably get good execution, but I haven't used those before.
- Misdicorl 7y ago
  The kickback is because the flow is uncorrelated with the market, not because the execution is worse. Robinhood would never be able to execute better than a good market maker. Ever.
- powowowow 7y ago
  It would be more accurate to frame payment for order flow as: "We get private institutions to offer you better than public prices; so you'll routinely buy each share a few cents lower, and sell a few cents higher than you would at a broker that does not offer this feature." The institution can do so not because it's a giant scam, but because they have confidence that a seller on RH is not about to sell a billion more of the same name, depressing the price. They know that it's going to be a small and essentially random trade, which is easier to risk manage.
- onetimemanytime 7y ago
  unless you buy and sell a gazillion times a day /week, does it really matter? Stock at $118.78 or $118.84 means what to Joe that invested $2400 ? NOTHING, the upside is that he actually invested and that money cannot be easily spent on stupid stuff. Free or barely free is the same in this case, considering that stocks can move up or down by a lot.
- egdod 7y ago
  Payment for order flow doesn’t mean you’re losing good order execution.
  - yellow_lead 7y ago
    Maybe, but do you think a brokerage that has paid for order flow will execute those orders in the investor's best interest? I'll be honest that I don't have the full picture, but happy to learn something new if it's a different story.
    - throwaway9d0291 7y ago
      They're required by law to give you execution at the market price or better, see https://www.sec.gov/fast-answers/answersbestexhtm.html https://www.sec.gov/fast-answers/answersbestexhtm.html Because of this, it's legally forbidden for them to mess with your prices in such a way that you lose anything. I think people see that these firms make money from selling order flow and as a result assume that they must be losing money somehow. That isn't the case. Some firms (e.g. HFT) are simply willing to pay a little extra for the counterparty to their trade to be a dumb joe instead of another HFT firm. This can lead to both you and the broker winning.
      - yellow_lead 7y ago
        That makes some more sense. I would like to get a better picture of how trading works in terms of exchanges, fees, and agreements though. I'll have to research this.
- smabie 7y ago
  Actually you’re probably getting better prices than institutional investors. HFT firms are willing to give better deals to individuals since they’re taking on less risk that the trader will move the market.
- neilparikh 7y ago
  I can't link to/find the article[1] because of Bloomberg's paywall, but Matt Levine of Money Stuff has said a few times that free trades in exchange for order flow is a good deal for retail investors. [1]- Maybe this one: https://www.bloomberg.com/opinion/articles/2019-05-21/the-trades-are-free-the-data-will-cost-you https://www.bloomberg.com/opinion/articles/2019-05-21/the-tr... ?
thefounder 7y ago
So the moved on from Bitcoin...expect similar bubbles soon!
- garmaine 7y ago
  Bitcoin is back on the rise btw... people are going into cryptocurrency not out now.
  - lozaning 7y ago
    Anecdotally, in the last 6 months none of the parents of kids I went to highschool with have cold called asking about crypto shit. People aren't leaving crypto, cause they already have all left.
    - garmaine 7y ago
      Back on the rise doesn’t imply max hype. Those are different parts of the cycle.
greesil 7y ago
Someone has got to be left holding the bag in the next downturn.
- SpikeDad 7y ago
  Exactly. No different than gambling. Stick to no fee mutuals and other balanced investments.
  - brookside 7y ago
    When the market turns sour it will be largely irrelevant if you own a collection of individual stocks or a packaged mutual fund, which is of course just a larger collection of stocks (or other securities).
    - smabie 7y ago
      If anything, diversification is going to hurt you. The idiosyncratic risk of holding only a few stocks is going to be a lot higher than if you have a bunch. As such, the correlation to the market is going to be lower, thus potentially helping during market downturns
      - andreilys 7y ago
        Depends on the diversification. If you hold uncorrelated bets, some may actually benefit from a global downturn
        ryandrake 7y ago
        Honest question: what kind of investment, equity or otherwise, would pay out in the event of a global downturn? Besides gold, canned food, and guns/ammo of course. I can imagine some kind of “contra world economy” fund but could you suggest an example?
        smabie 7y ago
brianbreslin 7y ago
Do we really think the reduction in trade costs from $10 to $0 is really driving consumer investors to dive in? Or is it the surge in stocks like tesla over the last year that is driving more speculation?
- ceejayoz 7y ago
  I don’t think it’ll dramatically change how much overall gets invested. I do think small investors will be more likely to actively manage their investments, though, which is against most of their interests.
- yellow_lead 7y ago
  It's more about the difficulty, but the cost is a part of it. People without a lot of money aren't going to go to the trouble of opening a brokerage to invest 200, 400, maybe $2000 dollars. Keep in mind you used to have to go to a physical brokerage or get on a call with an online firm before you could trade. When it's an app, and you can do it all from your couch, maybe that makes it worth it.
  - reaperducer 7y ago
    To build on that further, if you only have $100 in your existing account to invest, you're may not think it's worth it to buy a stock if 35% of it is going to be eaten up in fees. But if you can suddenly invest 100% of that $100, then it's far more worth doing.
  - kart23 7y ago
    Yes. Robinhood has made it so easy for teens and college students to quickly open an account and start trading. Literally just click buy, like amazon. Other online brokerages are more complicated and can be intimidating to new traders. A lot of them dont have much money in their accounts, so no fees is pretty valuable for them and the social aspect is big too.
- jimmaswell 7y ago
  I would've probably never gotten into stocks if there was a trade fee.
m3kw9 7y ago
If the trade is free you increase trade volume. Say fair weather stock investors come out an play, the more they trade the more they usually lose, and the more they need to refill their trading accounts from their hard earned Money.
- smabie 7y ago
  Why would they lose the more they trade? I mean yeah they’ll lose some on the spread but not very much. You would expect their returns on average to match the market.
  - perl4ever 7y ago
    People often imagine they'll make huge amounts of money by making a tiny amount on each trade, very frequently and consistently. The arithmetic on the percentages makes it appear possible. It just works just as well (or better/worse) in reverse. I'm not sure what's typical these days, but let's say the spread on a large cap liquid stock is 0.02% and the spread on a small cap illiquid stock is 0.40%. If you trade once a year, the cost is comparable to the management fees on an index fund. Not much, but already you're paying more than someone who is fully diversified. If you trade everything once a month, and average -0.40% each time, you are down 20% after five years! If you trade more frequently, say 200 times a year (not every day, but most days) and stick to the liquid stocks so that it only costs 0.02%, then you are also down roughly 20% after five years, before the actual returns.
    - m3kw9 7y ago
      Also you tend to lose when playing the short game, short game is more easily predicted by algorithms. So you are not only going against pros, you are going against machines that has speed and world class math phds
Barrin92 7y ago
>“There’s sometimes no fundamental reason for it. It just is based on perception — a perception based on narratives that run only an inch deep,” he said in a note. “Let’s see how much longer it persists. This kind of activity often unwinds much faster than the windup.” I think this is very, very risky. Families or individuals putting a lot of money into stock that is largely driven by the media and rally around the stock price increase is how you ruin people's financials. The Tesla stock mentioned in the article being one of them, as the recent bitcoin-esque rises are really hard to explain by fundamentals. But it seems to me to be the case for a lot of tech stock in particular. Lots of them going up 40% or 50% year over year yuo really have to ask at some point if this is going to continue for another ten years or if it's going to come down at some point.
neonate 7y ago
https://archive.md/6PDmQ https://archive.md/6PDmQ
jacquesm 7y ago
One of the best signs a crash is imminent (say within a couple of months) is when your family members start bragging about their stock holdings at parties. That's the time to get liquid if you haven't already done that by then. Of course that means you're indirectly still trying to time the market but at least you'll err on the safe side. I've earned a fair bit of money trading and would never put it down to anything but dumb luck and having enough reserves to be able to sit out the worst. If you're trading with money that you need you're doing it wrong.
- smabie 7y ago
  With free trading and the tight spreads on most equities and no edge, random trading shouldn’t hurt you that much. Your volatility will be worse, though. Sorry for the plug, but here’s a blog post I wrote about it: https://smabie.github.io/posts/2019/11/28/div.html https://smabie.github.io/posts/2019/11/28/div.html (Diversification, Risk, and Leverage). Or you can cut to the chase and check out this graph: https://smabie.github.io/assets/div.png https://smabie.github.io/assets/div.png We run a Monte-Carlo and find the average return and vol for randomly generated portfolios for 2 stocks up to 50. The average return for all portfolios is the same while the vol decreases as you add stocks to the portfolio. While high vol will hurt a compounding portfolio’s return due to volatility drag, the arithmetic return will be the same. So, in other words l, if you have zero skill trading today (essentially buying and selling randomly) you’re not, on average, going to underperform the market appreciably. As such, I don’t think it’s a problem for individuals to trade long equities with no leverage with money that they need (since it’s basically the same as the market). The problem is when people start trading forex derivatives or options or whatever. The volatility of these instruments can be staggeringly high which can lead to risk of ruin (St Petersburg paradox etc).
  - iudqnolq 7y ago
    Does your model still work if people don't trade completely randomly? I would expect the average small trader to behave similarly to many other small traders, and I would expect the trades they make to correlate with each other. I assume if you invest randomly you get more diversification than if you invest in companies that feel good to you.
dehrmann 7y ago
> The latest leg of their emergence times closely with October, when E-Trade, Charles Schwab and TD Ameritrade slashed commission fees to zero. It also times closely with the most meaningful rate cut by the Fed in five+ years.
altmind 7y ago
Why the brokerages are free and how do they make money https://news.ycombinator.com/item?id=20276551 https://news.ycombinator.com/item?id=20276551 (mostly, near zero yield for the cash on your brokerage accounts)

40 points by ilamont 7y ago

As others have pointed out, these "free trades" aren't actually free. In exchange, you lose good order execution. Brokerages like Robinhood seem to outsource this to other market makers which in turn give them a kickback for sending those orders their way.

phyek 7y ago
The average "mom and pop" investor can give 2 craps about trade execution. An execution price with a 20bps delta is MEANINGLESS to them.
- yellow_lead 7y ago
  I don't mean to imply that it's meaningful to them, but I think it's meaningful for this audience.
- Mountain_Skies 7y ago
  A friend was trying to convince me that high frequency trading was a good thing because of the liquidity it added to the market would allow me to sell my stock in milliseconds. If I've been holding a stock for twenty years, when I go to sell it, do I really care if it takes twenty minutes instead of twenty milliseconds? From the look on his face it was obvious that in his world investing in stocks long term is completely alien. Can't be too hard on him though, he did warn me of the Great Recession months in advance, with problems he was seeing in credit default swap pricing being what he considered the Archduke Ferdinand of the financial system.
  - perl4ever 7y ago
    "do I really care if it takes twenty minutes instead of twenty milliseconds?" No, nobody sensible cares. But the stuff people are suspicious of is supposed to be regulated so that your executions are only improved. If somehow this isn't true, it should be a bright line crossed and a big scandal with people going to jail or at least big fines. Then again, if you panic over a "flash crash", then I guess you should be concerned about liquidity?
  - yellow_lead 7y ago
    > If I've been holding a stock for twenty years, when I go to sell it, do I really care if it takes twenty minutes instead of twenty milliseconds? I think you may care actually. To give an example, I was holding a stock for several years that recently went up in price quickly, without much change in the underlying business. Simply, analysts started changing their rating on it. When this stock got high enough, I started to feel nervous, and I was watching the market open on a day when I was prepared to sell. Immediately, the stock started to tank, and I sold it right away. I sold it at a good price, and even though I was a long term investor, I made a short term decision to sell based off the (IMO) extremely irrational price.
dehrmann 7y ago
Where can one find better order execution? Citation needed, but I read the market makers buying these orders tend to get investors prices better than the bid-ask spread, so it's still good for retail investors. And it's not like it's any worse than when it was $10 per trade.
- yellow_lead 7y ago
  It's subjective but I'll recommend Interactive Brokers. Their trades cost $1. You can also go to a big brokerage like Goldman or Schwab and probably get good execution, but I haven't used those before.
Misdicorl 7y ago
The kickback is because the flow is uncorrelated with the market, not because the execution is worse. Robinhood would never be able to execute better than a good market maker. Ever.
powowowow 7y ago
It would be more accurate to frame payment for order flow as: "We get private institutions to offer you better than public prices; so you'll routinely buy each share a few cents lower, and sell a few cents higher than you would at a broker that does not offer this feature." The institution can do so not because it's a giant scam, but because they have confidence that a seller on RH is not about to sell a billion more of the same name, depressing the price. They know that it's going to be a small and essentially random trade, which is easier to risk manage.
onetimemanytime 7y ago
unless you buy and sell a gazillion times a day /week, does it really matter? Stock at $118.78 or $118.84 means what to Joe that invested $2400 ? NOTHING, the upside is that he actually invested and that money cannot be easily spent on stupid stuff. Free or barely free is the same in this case, considering that stocks can move up or down by a lot.
egdod 7y ago
Payment for order flow doesn’t mean you’re losing good order execution.
- yellow_lead 7y ago
  Maybe, but do you think a brokerage that has paid for order flow will execute those orders in the investor's best interest? I'll be honest that I don't have the full picture, but happy to learn something new if it's a different story.
  - throwaway9d0291 7y ago
    They're required by law to give you execution at the market price or better, see https://www.sec.gov/fast-answers/answersbestexhtm.html https://www.sec.gov/fast-answers/answersbestexhtm.html Because of this, it's legally forbidden for them to mess with your prices in such a way that you lose anything. I think people see that these firms make money from selling order flow and as a result assume that they must be losing money somehow. That isn't the case. Some firms (e.g. HFT) are simply willing to pay a little extra for the counterparty to their trade to be a dumb joe instead of another HFT firm. This can lead to both you and the broker winning.
    - yellow_lead 7y ago
      That makes some more sense. I would like to get a better picture of how trading works in terms of exchanges, fees, and agreements though. I'll have to research this.
smabie 7y ago
Actually you’re probably getting better prices than institutional investors. HFT firms are willing to give better deals to individuals since they’re taking on less risk that the trader will move the market.
neilparikh 7y ago
I can't link to/find the article[1] because of Bloomberg's paywall, but Matt Levine of Money Stuff has said a few times that free trades in exchange for order flow is a good deal for retail investors. [1]- Maybe this one: https://www.bloomberg.com/opinion/articles/2019-05-21/the-trades-are-free-the-data-will-cost-you https://www.bloomberg.com/opinion/articles/2019-05-21/the-tr... ?

thefounder 7y ago

So the moved on from Bitcoin...expect similar bubbles soon!

garmaine 7y ago
Bitcoin is back on the rise btw... people are going into cryptocurrency not out now.
- lozaning 7y ago
  Anecdotally, in the last 6 months none of the parents of kids I went to highschool with have cold called asking about crypto shit. People aren't leaving crypto, cause they already have all left.
  - garmaine 7y ago
    Back on the rise doesn’t imply max hype. Those are different parts of the cycle.

greesil 7y ago

Someone has got to be left holding the bag in the next downturn.

SpikeDad 7y ago
Exactly. No different than gambling. Stick to no fee mutuals and other balanced investments.
- brookside 7y ago
  When the market turns sour it will be largely irrelevant if you own a collection of individual stocks or a packaged mutual fund, which is of course just a larger collection of stocks (or other securities).
  - smabie 7y ago
    If anything, diversification is going to hurt you. The idiosyncratic risk of holding only a few stocks is going to be a lot higher than if you have a bunch. As such, the correlation to the market is going to be lower, thus potentially helping during market downturns
    - andreilys 7y ago
      Depends on the diversification. If you hold uncorrelated bets, some may actually benefit from a global downturn
      - ryandrake 7y ago
        Honest question: what kind of investment, equity or otherwise, would pay out in the event of a global downturn? Besides gold, canned food, and guns/ammo of course. I can imagine some kind of “contra world economy” fund but could you suggest an example?
        smabie 7y ago

brianbreslin 7y ago

Do we really think the reduction in trade costs from $10 to $0 is really driving consumer investors to dive in? Or is it the surge in stocks like tesla over the last year that is driving more speculation?

ceejayoz 7y ago
I don’t think it’ll dramatically change how much overall gets invested. I do think small investors will be more likely to actively manage their investments, though, which is against most of their interests.
yellow_lead 7y ago
It's more about the difficulty, but the cost is a part of it. People without a lot of money aren't going to go to the trouble of opening a brokerage to invest 200, 400, maybe $2000 dollars. Keep in mind you used to have to go to a physical brokerage or get on a call with an online firm before you could trade. When it's an app, and you can do it all from your couch, maybe that makes it worth it.
- reaperducer 7y ago
  To build on that further, if you only have $100 in your existing account to invest, you're may not think it's worth it to buy a stock if 35% of it is going to be eaten up in fees. But if you can suddenly invest 100% of that $100, then it's far more worth doing.
- kart23 7y ago
  Yes. Robinhood has made it so easy for teens and college students to quickly open an account and start trading. Literally just click buy, like amazon. Other online brokerages are more complicated and can be intimidating to new traders. A lot of them dont have much money in their accounts, so no fees is pretty valuable for them and the social aspect is big too.
jimmaswell 7y ago
I would've probably never gotten into stocks if there was a trade fee.

m3kw9 7y ago

If the trade is free you increase trade volume. Say fair weather stock investors come out an play, the more they trade the more they usually lose, and the more they need to refill their trading accounts from their hard earned Money.

smabie 7y ago
Why would they lose the more they trade? I mean yeah they’ll lose some on the spread but not very much. You would expect their returns on average to match the market.
- perl4ever 7y ago
  People often imagine they'll make huge amounts of money by making a tiny amount on each trade, very frequently and consistently. The arithmetic on the percentages makes it appear possible. It just works just as well (or better/worse) in reverse. I'm not sure what's typical these days, but let's say the spread on a large cap liquid stock is 0.02% and the spread on a small cap illiquid stock is 0.40%. If you trade once a year, the cost is comparable to the management fees on an index fund. Not much, but already you're paying more than someone who is fully diversified. If you trade everything once a month, and average -0.40% each time, you are down 20% after five years! If you trade more frequently, say 200 times a year (not every day, but most days) and stick to the liquid stocks so that it only costs 0.02%, then you are also down roughly 20% after five years, before the actual returns.
  - m3kw9 7y ago
    Also you tend to lose when playing the short game, short game is more easily predicted by algorithms. So you are not only going against pros, you are going against machines that has speed and world class math phds

Barrin92 7y ago

>“There’s sometimes no fundamental reason for it. It just is based on perception — a perception based on narratives that run only an inch deep,” he said in a note. “Let’s see how much longer it persists. This kind of activity often unwinds much faster than the windup.” I think this is very, very risky. Families or individuals putting a lot of money into stock that is largely driven by the media and rally around the stock price increase is how you ruin people's financials. The Tesla stock mentioned in the article being one of them, as the recent bitcoin-esque rises are really hard to explain by fundamentals. But it seems to me to be the case for a lot of tech stock in particular. Lots of them going up 40% or 50% year over year yuo really have to ask at some point if this is going to continue for another ten years or if it's going to come down at some point.

neonate 7y ago

https://archive.md/6PDmQ https://archive.md/6PDmQ

jacquesm 7y ago

One of the best signs a crash is imminent (say within a couple of months) is when your family members start bragging about their stock holdings at parties. That's the time to get liquid if you haven't already done that by then. Of course that means you're indirectly still trying to time the market but at least you'll err on the safe side. I've earned a fair bit of money trading and would never put it down to anything but dumb luck and having enough reserves to be able to sit out the worst. If you're trading with money that you need you're doing it wrong.

smabie 7y ago
With free trading and the tight spreads on most equities and no edge, random trading shouldn’t hurt you that much. Your volatility will be worse, though. Sorry for the plug, but here’s a blog post I wrote about it: https://smabie.github.io/posts/2019/11/28/div.html https://smabie.github.io/posts/2019/11/28/div.html (Diversification, Risk, and Leverage). Or you can cut to the chase and check out this graph: https://smabie.github.io/assets/div.png https://smabie.github.io/assets/div.png We run a Monte-Carlo and find the average return and vol for randomly generated portfolios for 2 stocks up to 50. The average return for all portfolios is the same while the vol decreases as you add stocks to the portfolio. While high vol will hurt a compounding portfolio’s return due to volatility drag, the arithmetic return will be the same. So, in other words l, if you have zero skill trading today (essentially buying and selling randomly) you’re not, on average, going to underperform the market appreciably. As such, I don’t think it’s a problem for individuals to trade long equities with no leverage with money that they need (since it’s basically the same as the market). The problem is when people start trading forex derivatives or options or whatever. The volatility of these instruments can be staggeringly high which can lead to risk of ruin (St Petersburg paradox etc).
- iudqnolq 7y ago
  Does your model still work if people don't trade completely randomly? I would expect the average small trader to behave similarly to many other small traders, and I would expect the trades they make to correlate with each other. I assume if you invest randomly you get more diversification than if you invest in companies that feel good to you.

dehrmann 7y ago

> The latest leg of their emergence times closely with October, when E-Trade, Charles Schwab and TD Ameritrade slashed commission fees to zero. It also times closely with the most meaningful rate cut by the Fed in five+ years.

altmind 7y ago

Why the brokerages are free and how do they make money https://news.ycombinator.com/item?id=20276551 https://news.ycombinator.com/item?id=20276551 (mostly, near zero yield for the cash on your brokerage accounts)