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Robinhood has been criticized a bunch for taking payment for order flow, but I've yet to see someone actually make a quantitative case that if you make an $x tr

by paulgb 6y ago

Robinhood has been criticized a bunch for taking payment for order flow, but I've yet to see someone actually make a quantitative case that if you make an $x trade you will lose $y on average because of PFOF. The argument instead always relies on a zero-sum figuring that if someone else is willing to pay for the order flow it must be costing you somehow, but that's not really how it works.

bcherny 6y ago
That’s not the problem with making money off order flow. The problem is that it fundamentally misaligns incentives: while Robinhood makes money the more people transact (and is the reason its fee structure and UX incentivize transacting), it’s not in peoples’ financial best interest to transact as often as possible.
- cwyers 6y ago
  But that's true of brokers that charge customers per trade too: they too are incentivized for customers to trade more.
  - bcherny 6y ago
    Maybe. I’d be curious to see a breakdown of a traditional broker’s revenue compared to Robinhood. I bet Robinhood makes most of its money off order flow (it was founded by HFT traders, after all), while traditional brokers make more money off fees, reinvesting, upselling other products, etc.
    - bostik 6y ago
      IIRC traditional brokers make most of their money off of interest on their float. I wish I could remember where this came up because without a solid reference it sounds utterly absurd.
      - disgruntledphd2 6y ago
        That doesn't surprise me at all, given that most insurers make all their money off investing the premiums before claims happen. When part of your service is to hold money, it's kinda the natural business model. Of course, this is not working out well for insurers in a world of very low interest rates (which is one of the reasons lots of insure-tech startups are getting funded now).
      - thedufer 6y ago
        I'm not sure if this is the source you meant, but patio11 wrote a good overview of various brokerages' revenue sources: https://www.kalzumeus.com/2019/6/26/how-brokerages-make-money/ https://www.kalzumeus.com/2019/6/26/how-brokerages-make-mone...
- gnicholas 6y ago
  Exactly. And apparently their order flow compensation differs in a key way — they make more money not just based on how often you trade, but on the size of the bid-ask spread. > Also, Robinhood’s compensation model differs from E-Trade and other firms. As an analysis by the investment bank Piper Sandler put it this summer, “Robinhood receives a fixed rate per spread (vs. a fixed rate per share by the other eBrokers).”
logicslave 6y ago
All the other retail brokers except interactive brokers also take payment for order flow
- benmanns 6y ago
  IBKR Lite takes payment for order flow, which is IBKR’s commission free account type. You can look up a brokers 606 report for info.
  - logicslave 6y ago
    Whats funny though is options trading on robinhood is "free". I've tested robinhoods execution versus charles schwabb, theres really not much difference. Schwabb charges .65 cents a contract, if you make a 50k options trade, it could be hundreds to open and close. Robinhood is giving these brokerages a run for their money
jrumbut 6y ago
The issue is that the only people with access to the information to make a case are the ones making money on it. There's a lack of transparency. And it's not just a theoretical concern, the article states that Robinhood has already been fined for not executing orders at the best price.

by paulgb 6y ago

bcherny 6y ago

That’s not the problem with making money off order flow. The problem is that it fundamentally misaligns incentives: while Robinhood makes money the more people transact (and is the reason its fee structure and UX incentivize transacting), it’s not in peoples’ financial best interest to transact as often as possible.

cwyers 6y ago
But that's true of brokers that charge customers per trade too: they too are incentivized for customers to trade more.
- bcherny 6y ago
  Maybe. I’d be curious to see a breakdown of a traditional broker’s revenue compared to Robinhood. I bet Robinhood makes most of its money off order flow (it was founded by HFT traders, after all), while traditional brokers make more money off fees, reinvesting, upselling other products, etc.
  - bostik 6y ago
    IIRC traditional brokers make most of their money off of interest on their float. I wish I could remember where this came up because without a solid reference it sounds utterly absurd.
    - disgruntledphd2 6y ago
      That doesn't surprise me at all, given that most insurers make all their money off investing the premiums before claims happen. When part of your service is to hold money, it's kinda the natural business model. Of course, this is not working out well for insurers in a world of very low interest rates (which is one of the reasons lots of insure-tech startups are getting funded now).
    - thedufer 6y ago
      I'm not sure if this is the source you meant, but patio11 wrote a good overview of various brokerages' revenue sources: https://www.kalzumeus.com/2019/6/26/how-brokerages-make-money/ https://www.kalzumeus.com/2019/6/26/how-brokerages-make-mone...
gnicholas 6y ago
Exactly. And apparently their order flow compensation differs in a key way — they make more money not just based on how often you trade, but on the size of the bid-ask spread. > Also, Robinhood’s compensation model differs from E-Trade and other firms. As an analysis by the investment bank Piper Sandler put it this summer, “Robinhood receives a fixed rate per spread (vs. a fixed rate per share by the other eBrokers).”

logicslave 6y ago

All the other retail brokers except interactive brokers also take payment for order flow

benmanns 6y ago
IBKR Lite takes payment for order flow, which is IBKR’s commission free account type. You can look up a brokers 606 report for info.
- logicslave 6y ago
  Whats funny though is options trading on robinhood is "free". I've tested robinhoods execution versus charles schwabb, theres really not much difference. Schwabb charges .65 cents a contract, if you make a 50k options trade, it could be hundreds to open and close. Robinhood is giving these brokerages a run for their money

jrumbut 6y ago

The issue is that the only people with access to the information to make a case are the ones making money on it. There's a lack of transparency. And it's not just a theoretical concern, the article states that Robinhood has already been fined for not executing orders at the best price.