5 ms·

ELI5: why exactly did the clients get bad execution? Does sending order flow to trading firms in itself cause unfavorable execution? Or did the trading firms

by _cs2017_ 6y ago

ELI5: why exactly did the clients get bad execution? Does sending order flow to trading firms in itself cause unfavorable execution? Or did the trading firms treat order flow from RH differently than from other sources? Or is it something else? And does the fact that RH was receiving large payments for order flow impact the quality of execution?

bagacrap 6y ago
Payment for order flow trade never helps the consumer. RH accepted unusually large amounts of it. They harmed the consumers to the tune of $34m relative to normal practices. They lied about what they were doing.
- Kranar 6y ago
  This is incorrect. The benefit of order flow to the consumer is additional sources of liquidity. If a consumer submits an order to buy 500 shares of AAPL for $100, there may only be 100 shares available on the public market at that price in which case the price of AAPL will increase from $100 to at a minimum $100.01. The way pay for flow works is that firms can execute against that order agreeing to fill any portion of it up to and including the full 500 shares. Furthermore by agreeing to pay for flow, it's a criminal offense for my firm to use that information to front run the order by buying it on the open market without first executing against the client. The allegation made by the SEC against Robinhood is that some kind of indirect front running was performed and perhaps even facilitated by Robinhood. The problem is that the SEC is pretty weak overall, and if their allegation is true then Robinhood should be punished much more severely than this $65M fine given that Robinhood and others likely profited at a minimum some $40M dollars.
  - _cs2017_ 6y ago
    The quality of comments in this thread is atrocious. I wonder what makes so many presumably technically trained people, to make confident claims about topics on which they very clearly have no bloody clue.
- smabie 6y ago
  payment for order flow helps the consumer a lot. By separating toxic from non-toxic order flows, retail traders get much better price improvements than institutional traders.
gypsy_boots 6y ago
> Or did the trading firms treat order flow from RH differently than from other sources? I'm not well versed in financial language by any stretch, but i believe it's this. Matt Taibbi did a piece on them last week and goes into this. https://taibbi.substack.com/p/pandemic-villains-robinhood https://taibbi.substack.com/p/pandemic-villains-robinhood
- aksss 6y ago
  That was a good article.
- _cs2017_ 6y ago
  The article seems somewhat on the fluff-and-feathers side. It doesn't really explain anything. The only non-obvious thing it says is: > Robinhood receives a fixed rate per spread (vs. a fixed rate per share by the other eBrokers). Rather than receiving simple payment by volume, Robinhood receives a percentage of the spread between the bid and the ask in each trade. This is interesting because while HFT proponents insist their practices narrow spreads, some critics maintain that high-frequency trading ends up widening spreads. Unfortunately, what this excerpt claims as "interesting" makes no logical sense. The fact that RH is paid by HFT on the spread would suggest that HFT like to get order flow in stocks that already have a large spread. It is completely unclear how this is related to the claim that HFT tend to increase the spread. The "traditional" interpretation is that HFT make money from creating liquidity. This means they take illiquid stocks (with large spread) and make them liquid (reducing the spread). Since they make money doing that, they are willing to pay for orders in illiquid stocks. Is this the correct interpretation? I have no clue. But it seems the article's author has even less clue, and adds nothing of value to the discussion.
himoacs 6y ago
Basically, if you want to buy AAPL at $100 and as your broker, I take that info and share it with someone else, such as an HFT, they will quickly (milliseconds/nanoseconds) buy AAPL and sell you at a higher price. So, while you expected to pay $100, you ended up paying $100.10. Now that doesn't seem a lot to you but times the difference (10 cents) by volume and number of Robinhood customers placing orders and it can add up to be a lot.
- saddlerustle 6y ago
  That's not true. A $100 buy order will only ever execute at $100.
  - dangus 6y ago
    The default trade option on Robinhood isn’t a dollar value buy order. It’s a number of shares order at the market rate.
  - mtcoope 6y ago
    Not a market order which majority of people on Robinhood are using market orders since they are the default. Most don't even know what a limit order is I'm guessing.
  - Kranar 6y ago
    This is wrong on several levels. First of all limit orders place a limit on the worst case price that can be executed but SEC rules impose a duty to execute orders at the best price. If there's a $100 buy order and the best price is 99 dollars, then there is a duty to fill the order at 99 dollars. Second, the allegation made by the SEC, for which they most likely have very strong evidence, is that Robinhood didn't fulfill its duty to execute orders at the best price to the tune of some 30 million dollars.
- treis 6y ago
  This is front running and illegal.
  - 6y ago
deleted 6y ago
[deleted]
dcolkitt 6y ago
Here's an analogy I once heard from Matt Andresen (founder of Island, one of the major early electronic exchanges). Equity markets are like a high-end clubs in Miami. A club that doesn't make any effort at "face control" at the door will find that it's ratio of guys-to-girls will continuously skew higher. And both groups will eventually stop going to any venue where the guy-to-girl ratio is persistently too high. However guys generally are willing to pay more than girls for entry, so it's a balancing act between maximizing short-term revenue and long-term brand value. Similarly in any given market there's the ratio of informed trading to uninformed trading. Generally the former are large institutions, and the latter are small retail daytraders like the Robinhood customers. Since active management is a zero sum game, a venue with all informed traders is not a place you want to trade at. By law the public exchanges are not allowed to segment order flow. Imagine a club that's legally prohibited from discriminating based on gender at the door. As you can imagine, the ratio at these venue is extremely biased towards informed traders. Dark pools and internalizers are not bound by that restriction. However they're legally obligated to meet or beat the best price in the public market. (More on that in a second.) Retail brokers like Robinhood are essentially like club promoters, whose job is to get paid for bringing as many pretty girls to these venues as possible. And on the other side the informed traders at these venues (usually just the internal prop desk) pay big money for the privilege of trading somewhere with such a good ratio. Is this a bad deal for the girls being herded by club promoters? To a first order approximation: no. At the very least they're getting free entry and drinks, instead of paying listed fees at the public venues. Sometimes they even get other perks like free meals or zero-commissions from the promoter. Still it feels exploitive because the promoter is making far more money off the girls than any fringe benefits they're getting. As a second-order effect, the segmentation may degrade the overall ecosystem. Eventually all the girls wind up at the private clubs, and the public ones become ~100% dudes. Analogously the public lit exchanges have become highly toxic. Which is bad because market makers set prices based on the quality of the flow they interact with. Remember that price protection on dark pools is based on the best price available at the lit exchanges. This creates a negative feedback loop. Dark venues can improve on prices at lit exchanges by segmenting order flow. Which forces lit market makers to worsen their prices. Which gives the dark venues even more of an advantage, allowing them to price out even more desirable order flow. Which then makes the lit order flow even more toxic, and the public quotes worsen. Which then drives even more flow to dark pools and internalizers...

bagacrap 6y ago

Payment for order flow trade never helps the consumer. RH accepted unusually large amounts of it. They harmed the consumers to the tune of $34m relative to normal practices. They lied about what they were doing.

Kranar 6y ago
This is incorrect. The benefit of order flow to the consumer is additional sources of liquidity. If a consumer submits an order to buy 500 shares of AAPL for $100, there may only be 100 shares available on the public market at that price in which case the price of AAPL will increase from $100 to at a minimum $100.01. The way pay for flow works is that firms can execute against that order agreeing to fill any portion of it up to and including the full 500 shares. Furthermore by agreeing to pay for flow, it's a criminal offense for my firm to use that information to front run the order by buying it on the open market without first executing against the client. The allegation made by the SEC against Robinhood is that some kind of indirect front running was performed and perhaps even facilitated by Robinhood. The problem is that the SEC is pretty weak overall, and if their allegation is true then Robinhood should be punished much more severely than this $65M fine given that Robinhood and others likely profited at a minimum some $40M dollars.
- _cs2017_ 6y ago
  The quality of comments in this thread is atrocious. I wonder what makes so many presumably technically trained people, to make confident claims about topics on which they very clearly have no bloody clue.
smabie 6y ago
payment for order flow helps the consumer a lot. By separating toxic from non-toxic order flows, retail traders get much better price improvements than institutional traders.

gypsy_boots 6y ago

> Or did the trading firms treat order flow from RH differently than from other sources? I'm not well versed in financial language by any stretch, but i believe it's this. Matt Taibbi did a piece on them last week and goes into this. https://taibbi.substack.com/p/pandemic-villains-robinhood https://taibbi.substack.com/p/pandemic-villains-robinhood

aksss 6y ago
That was a good article.
_cs2017_ 6y ago
The article seems somewhat on the fluff-and-feathers side. It doesn't really explain anything. The only non-obvious thing it says is: > Robinhood receives a fixed rate per spread (vs. a fixed rate per share by the other eBrokers). Rather than receiving simple payment by volume, Robinhood receives a percentage of the spread between the bid and the ask in each trade. This is interesting because while HFT proponents insist their practices narrow spreads, some critics maintain that high-frequency trading ends up widening spreads. Unfortunately, what this excerpt claims as "interesting" makes no logical sense. The fact that RH is paid by HFT on the spread would suggest that HFT like to get order flow in stocks that already have a large spread. It is completely unclear how this is related to the claim that HFT tend to increase the spread. The "traditional" interpretation is that HFT make money from creating liquidity. This means they take illiquid stocks (with large spread) and make them liquid (reducing the spread). Since they make money doing that, they are willing to pay for orders in illiquid stocks. Is this the correct interpretation? I have no clue. But it seems the article's author has even less clue, and adds nothing of value to the discussion.

himoacs 6y ago

Basically, if you want to buy AAPL at $100 and as your broker, I take that info and share it with someone else, such as an HFT, they will quickly (milliseconds/nanoseconds) buy AAPL and sell you at a higher price. So, while you expected to pay $100, you ended up paying $100.10. Now that doesn't seem a lot to you but times the difference (10 cents) by volume and number of Robinhood customers placing orders and it can add up to be a lot.

saddlerustle 6y ago
That's not true. A $100 buy order will only ever execute at $100.
- dangus 6y ago
  The default trade option on Robinhood isn’t a dollar value buy order. It’s a number of shares order at the market rate.
- mtcoope 6y ago
  Not a market order which majority of people on Robinhood are using market orders since they are the default. Most don't even know what a limit order is I'm guessing.
- Kranar 6y ago
  This is wrong on several levels. First of all limit orders place a limit on the worst case price that can be executed but SEC rules impose a duty to execute orders at the best price. If there's a $100 buy order and the best price is 99 dollars, then there is a duty to fill the order at 99 dollars. Second, the allegation made by the SEC, for which they most likely have very strong evidence, is that Robinhood didn't fulfill its duty to execute orders at the best price to the tune of some 30 million dollars.
treis 6y ago
This is front running and illegal.
- 6y ago

deleted 6y ago

[deleted]

dcolkitt 6y ago

Here's an analogy I once heard from Matt Andresen (founder of Island, one of the major early electronic exchanges). Equity markets are like a high-end clubs in Miami. A club that doesn't make any effort at "face control" at the door will find that it's ratio of guys-to-girls will continuously skew higher. And both groups will eventually stop going to any venue where the guy-to-girl ratio is persistently too high. However guys generally are willing to pay more than girls for entry, so it's a balancing act between maximizing short-term revenue and long-term brand value. Similarly in any given market there's the ratio of informed trading to uninformed trading. Generally the former are large institutions, and the latter are small retail daytraders like the Robinhood customers. Since active management is a zero sum game, a venue with all informed traders is not a place you want to trade at. By law the public exchanges are not allowed to segment order flow. Imagine a club that's legally prohibited from discriminating based on gender at the door. As you can imagine, the ratio at these venue is extremely biased towards informed traders. Dark pools and internalizers are not bound by that restriction. However they're legally obligated to meet or beat the best price in the public market. (More on that in a second.) Retail brokers like Robinhood are essentially like club promoters, whose job is to get paid for bringing as many pretty girls to these venues as possible. And on the other side the informed traders at these venues (usually just the internal prop desk) pay big money for the privilege of trading somewhere with such a good ratio. Is this a bad deal for the girls being herded by club promoters? To a first order approximation: no. At the very least they're getting free entry and drinks, instead of paying listed fees at the public venues. Sometimes they even get other perks like free meals or zero-commissions from the promoter. Still it feels exploitive because the promoter is making far more money off the girls than any fringe benefits they're getting. As a second-order effect, the segmentation may degrade the overall ecosystem. Eventually all the girls wind up at the private clubs, and the public ones become ~100% dudes. Analogously the public lit exchanges have become highly toxic. Which is bad because market makers set prices based on the quality of the flow they interact with. Remember that price protection on dark pools is based on the best price available at the lit exchanges. This creates a negative feedback loop. Dark venues can improve on prices at lit exchanges by segmenting order flow. Which forces lit market makers to worsen their prices. Which gives the dark venues even more of an advantage, allowing them to price out even more desirable order flow. Which then makes the lit order flow even more toxic, and the public quotes worsen. Which then drives even more flow to dark pools and internalizers...