10 ms·

Breaking down the 'payment for order flow' debate

67 points by alihm 5y ago

PaulHoule 5y ago
Trouble is the NBBO is not really the best price you could get.
- nuclearnice3 5y ago
  What is really the best price you could get?
  - gruez 5y ago
    other market-makers/HFTs
- TacticalCoder 5y ago
  Well that's what the article is saying, right? > "Wholesale market makers typically provide price better than the National Best Bid/Offer"
  - marketmakerx 5y ago
    The NBBO would be narrower without wholesale market makers.
    - nuclearnice3 5y ago
      What evidence or theory should lead me to believe this?
      - marketmakerx 5y ago
        The flow on the market becomes much more toxic after the uninformed retail flow is siphoned away.
        nuclearnice3 5y ago
        Thanks! That makes sense to me. Wider prices because more dangerous orders.
al2o3cr 5y ago
"Are the xenomorphs a threat to human civilization, or a great opportunity for scientific advancement? As investors in Weyland-Utani, we're here to explain why they're the latter."
- JohnJamesRambo 5y ago
  I really enjoyed this.
marketmakerx 5y ago
What they ignore is that the NBBO spread is made larger by this practice. By siphoning off all the uninformed flow, leaving only the toxic flow, this then causes people to quote wide spreads on regular exchanges, making the NBBO spread larger than it otherwise would be.
- evrydayhustling 5y ago
  Yes, this article boils down to three pages of "it's complicated" followed by "the market makers publish stats that say they are great for retail". And as you point out, the stats cited ignore that the market makers play a big role determining the reference point against which "improvement" is measured.
- ypzhang2 5y ago
  Yes but if you tighten nbbo by mixing retail and institutional orders, it by definition will still be worse than the retail market maker price, so end result is worse for the consumer anyways?
  - marketmakerx 5y ago
    Not by definition. If that uninformed flow is going to market, there is a good market design to encourage price competition among MMs who fight each other for time and price priority. That mechanism is obstructed under payment for flow. Under this, the MM only needs to give at or better than NBBO. The primary competition among MMs here is to pass on as much rents to brokers as possible, instead of minimizing rents in the first place. The market is also more prone to consolidation due to scale economies and informational advantages that private flow access provides. I also dispute the clean distinction between retail and institutional. Much institutional flow is just funds (e.g pension funds) that hold retail money. If they're getting maximally screwed by this, then so are their investors.
- alpineidyll3 5y ago
  Yeah, hiding behind second order thinking is a great defense :/ It seems a regrettably tiny fraction of people can take a step back and think about the basic amount of profit citadel makes per trade without actually serving as a counterparty for a period of time most humans can even measure. Pfof actually exists because exchanges and broker dealers are legally prohibited from doing the same thing. Citadel is just a external way of receiving this income as a kickback for the likes of RH.
protoax 5y ago
Struggling to see why this should be taken in any way seriously considering the clear conflict of interest?
- naveen99 5y ago
  Clear conflicts of interest are usually fine. It’s the unclear or hidden ones that are sometimes problematic. I mean judges trust lawyers to argue cases on behalf of their clients with a declared conflict of interest to opposing counsel.
- nsonha 5y ago
  just read it and see if it makes sense, if you are not confident to form an opinion, there is always the option not to.
- kragen 5y ago
  Because it explains how equities markets work, mostly correctly, and this is background knowledge you need if you are buying or selling equities or forming opinions about capitalism or things like "clear conflict[s] of interest".
- lordnacho 5y ago
  Suppose you become knowledgeable about some area. You find there is an investment opportunity, so you invest. You tell your friends about it. Should they discount your knowledge because you've acted on it? I happen to disagree with the article, but I didn't dismiss it just because it was written by someone with an interest. Quite a lot of opinion about things in the world is written by informed people who have an interest in one side or another. You can read critically and decide which parts make sense to you and which do not.
- throw0101a 5y ago
  > considering the clear conflict of interest? Because: > You judged something as either good or bad on the basis of where it comes from, or from whom it came. > This fallacy avoids the argument by shifting focus onto something's or someone's origins. It's similar to an ad hominem fallacy in that it leverages existing negative perceptions to make someone's argument look bad, without actually presenting a case for why the argument itself lacks merit. * https://yourlogicalfallacyis.com/genetic https://yourlogicalfallacyis.com/genetic
kilna 5y ago
"In the wake of the GameStop short squeeze" Riiiiiiight.
kingTug 5y ago
Were short positions that caused the GameStop frenzy closed or not? I can never come up with an answer when I go looking for evidence.
- gregoryjjb 5y ago
  They were mostly closed prior to the huge price spike, the spike was caused by retail buying, probably thinking they were causing a squeeze. You can read the details in the SEC report on the topic (note the massive drop in short interest in Figure 5). https://www.sec.gov/files/staff-report-equity-options-market-struction-conditions-early-2021.pdf https://www.sec.gov/files/staff-report-equity-options-market...
  - tartoran 5y ago
    Doesn’t closing positions cause a price spike in the first place? It seems to me that they kicked the can down the road waiting for a better opportunity to do so.
    - gregoryjjb 5y ago
      It did cause some price spiking, but the FOMO caused a much bigger spike and eclipsed the effects of the squeeze. Why do you think they "kicked the can down the road"? Short interest is still around 1%, down from over 100% in January. The hedge funds in question realized huge losses in Q1.
- jimmydorry 5y ago
  From the SEC report: >By the end of January 2021, some funds had closed out their short positions in meme stocks, realizing significant losses. 62 In contrast, some funds that were long GME saw significant gains.63 Some investors that had been invested in the target stocks prior to the market events benefitted unexpectedly from the price rises,64 while others, including quantitative and high-frequency hedge funds, joined the market rally to trade profitably.65 Staff believes that hedge funds broadly were not significantly affected by investments in GME and other meme stocks. Staff did not observe that any advisers to private funds and registered funds experienced liquidity issues or difficulties with counterparties. Their sources for this are various news articles that were told this by hedge funds or anonymous sources. It is mentioned somewhere in the report that the SEC does not have the data or capability of detecting naked shorting. All we can know is that the short positions definitely existed at one point, but that's about it. >GME short interest hit 50% of shares outstanding first in 2012 and then again in 2015, 2016, and 2018, before rising even further in 2019. From then until early 2021, GME short interest hovered around 100%, hitting its high of 109.26% on December 31, 2020. https://www.sec.gov/files/staff-report-equity-options-market-struction-conditions-early-2021.pdf https://www.sec.gov/files/staff-report-equity-options-market...
cletus 5y ago
First strange thing: this post just mentions GameStop and leaves that hanging in the air without explanation. I assume this is because of the sale of order flow at Ronbinhood in particular but it still seems odd. Second, the real estate thing is a weird tangent. I just don't buy that adding an intermediary to real estate transactions is the win-win-win claimed. This seems like a weird detour to justify Opendoor (which, it should be noted, A16Z was an investor in). Let me use this as an analogy though. Imagine the NBBO-equivalent for house sales was a 10% broker fee split between buyer's broker and seller's broker. What this post is arguing is that the sale of order flow is fine because most people pay less than 10% this way. Thing is, once you decide to buy or sell that house, you're doing so without necessarily knowing what the price will be or how much commission you'll pay other than "probably less than 10%". Whoever is processing that is free to take that buy or sell order and then act before processing it. In financial markets, this is called frontrunning. Some markets allow it, some don't. Worse, you as an investor have less visibility into what's going on because these trades through a variety of different brokerages or exchanges can essentially occur off-market. So I'm not buying whatever this is selling. Side note: I honestly don't understand the popularity of Robinhood. It's amazing how willing many on HN are to castigate ad-supported models and the sale of user data while seemingly at the same time being completely fine with the sale of their order flow.
- djbusby 5y ago
  Robinhood is fun! Really. Like, compared to IB, TD or Fidelity it's FUN. And game-ified so it had a cute ding when you get a green up arrow! A Skinner Box for your money management. Humans (and rats) love to press the lever to get the reward.
  - hckrnrd 5y ago
    I wholeheartedly agree. Compared to ToS and IB, RH makes derivative gambling a blast. At least the platform calls a spade a spade—it’s not for the boggle heads, but rather for those interested in taking on risk. And if your investment time horizon is measured in decades, instead of years, it makes perfect sense to me.
- 5y ago
IAmGraydon 5y ago
I have a problem with any article that starts off by making a false statement in the first sentence. GME was not a short squeeze. The SEC did a very detailed analysis, which was released recently, and it’s pretty cut and dry - GME went up because of a massive number of retail traders buying the underlying. Short covering contributed very little to the upward momentum.
- garmaine 5y ago
  That is splitting hairs to avoid reality. WSB found an over-subscribed short position and exploited it. But because this happened in public, A LOT of people piled on. So in the end the main thing moving the price was the WSB hype, but the squeeze was still there. It was the trigger that made everything else happen.
  - IAmGraydon 5y ago
    No, it wasn’t. Read the report.
    - clove 5y ago
      You don't need to read the report if you're familiar with the stock. I've been following the stock for several years, and before WSB it has been undervalued, pushing penny stock level despite being a ~10-20 dollar stock in terms of DCF. Short interest on GME has been around 100% for years now, and surpassed 100% prior to the WSB stuff. Why do you trust the SEC more than short interest numbers?
    - sonotathrowaway 5y ago
      This is the report: 3.4 Short Selling and Covering Short Positions GameStop at the time was notable for its significant short interest (the ratio of shares currently sold short to shares outstanding).74 Figure 5 shows GME’s short interest over time, along with average levels of short interest among other non-financial common stocks. In the past, GME had several periods of high short interest, but none as high as the levels achieved from 2019 to mid-January 2021. GME short interest hit 50% of shares outstanding first in 2012 and then again in 2015, 2016, and 2018, before rising even further in 2019. From then until early 2021, GME short interest hovered around 100%, hitting its high of 109.26% on December 31, 2020. Some commentators have asked how short interest can get as high as it did in GameStop. Short interest can exceed 100%—as it did with GME—when the same shares are lent multiple times by successive purchasers. If someone purchases a stock from a short seller and subsequently lends the stock out again, it will appear as if the stock was sold short twice for the purpose of the short interest calculation.75 Short interest ratios tend to be quite low; for large non-financial stocks, they are often less than 2.5% whereas for small non-financial stocks they still tend to be less than 13%. Few stocks, if any, have short interest greater than 50% on a given date.76 Until recently, short interest of more than 90% was observed only a few times—in 2007 and 2008. When examining short interest as a percent of shares outstanding, GME is the only stock that staff observed as having short interest of more than shares outstanding in January 2021. What’s the difference between a short squeeze and short sellers are buying to close their positions 2021, GME short interest hovered around 100%, hitting its high of 109.26% on December 31, 2020. Some commentators have asked how short interest can get as high as it did in GameStop. Short interest can exceed 100%—as it did with GME—when the same shares are lent multiple times by successive purchasers. If someone purchases a stock from a short seller and subsequently lends the stock out again, it will appear as if the stock was sold short twice for the purpose of the short interest calculation.75 Short interest ratios tend to be quite low; for large non-financial stocks, they are often less than 2.5% whereas for small non-financial stocks they still tend to be less than 13%. Few stocks, if any, have short interest greater than 50% on a given date.76 Until recently, short interest of more than 90% was observed only a few times—in 2007 and 2008. When examining short interest as a percent of shares outstanding, GME is the only stock that staff observed as having short interest of more than shares outstanding in January 2021.
Negitivefrags 5y ago
Since everyone in this thread seems determined to dismiss this take entirely due to who is saying it, perhaps people would prefer this article by Matt Lavine explaining much the same thing? https://www.bloomberg.com/opinion/articles/2021-02-05/robinhood-gamestop-saga-pressures-payment-for-order-flow https://www.bloomberg.com/opinion/articles/2021-02-05/robinh... Hint: PFOF is fine.
- unmole 5y ago
  You want me to take a Goldman Sachs alum's word when he says whatever Wall Street is doing to retail investors is fine? /s
- camgunz 5y ago
  From that article: > Now of course I am oversimplifying. For one thing, the wholesalers don’t have to fill every order out of inventory; they will do that with some orders and pass others on to the exchange to execute. They do not provide price improvement on 100% of orders, though they do compete to provide price improvement and are evaluated by brokers based on how much they provide. They will often lay off risk on the public markets rather than trading exclusively with retail customers; often they will be in the business of market making on the exchanges too, and will manage that business and the retail business in some interacting way. Anyone who trades a lot of stock benefits from having information about order flow, and a wholesaler who sees a lot of retail orders will have some informational advantages in its public trading. Or TL;DR: the NBBO benefit pointed to by OP isn't absolute, order flow is valuable information, and rather than being some kind of exchange utility wholesalers are actually trying to maximize their own profits. I'm fine with this? I'm not fine with how OP characterizes them, which doesn't seem aligned.
  - smabie 5y ago
    Of course market makers are trying to maximize profit: they are trading firms just like any others. However, retail order flow is (pretty much by definition) not particularly valuable information: if it was, wholesalers would be unwilling to consistently take the other side at such good prices. Of course order flow in general is highly valuable information, it's just that retail order flow isn't because it's very non-toxic (there is little to no predictive signal in the flow).
sushsjsuauahab 5y ago
What does the world gain from finance? I am a bit confused. Seems to me that the only important things are assets, labor, and sometimes a medium of exchange. Just because I have a mortgage and a credit card doesn't mean I can't survive without them. Now that we have computers, most of us are actually and literally creating something out of nothing.
- pgwhalen 5y ago
  Finance allocates capital and moves risk from parties who don't want it towards parties who do want it. > Just because I have a mortgage and a credit card doesn't mean I can't survive without them. You could definitely survey without them, the same way you could survive without a car or a smartphone. A mortgage in particular is undeniably useful for many people.
  - sushsjsuauahab 5y ago
    Only because housing prices have been artificially inflated? I can prove how they are, but curious to know if you agree they are. Finance is a bandaid for deeper issues.
    - icebraining 5y ago
      Only because they have been artificially inflated? That seems unlikely; the materials and labor costs alone would take multiple years to pay off by an average family. Being able to move in immediately seems useful, even if currently we're paying way too much for it.
    - smabie 5y ago
      I mean finance has existed for thousands of years. What are these deeper issues? Whatever they are it seems unlikely they are ever going away.
- FabHK 5y ago
  > What does the world gain from finance? Not sure whether you're asking seriously, but while there is a lot of scamming and rent seeking in finance (which is why it is subject to heavy regulation), it does provide many functions: 1. transfer of purchasing power through time (by saving/credit) 2. proper valuation 3. facilitation of investments (for companies, infrastructure, etc.) 4. investment allocation 5. risk transfer and management etc. All valuable functions. > most of us are actually and literally creating something out of nothing Your labour and your computer and the electricity used to run that computer etc. are not nothing. The economy has always been about creating something more valuable out of inputs that are less valuable. Nothing new here.
FabHK 5y ago
> Retail brokers typically route orders to a handful of market makers, allocating more to the market makers that provide the highest amount of price improvement to the retail investors. Do they? Or would they typically allocate more to the market makers that pay them the largest kick-back ("payment for order flow")? (Not that that is inherently wrong, but it is not quite as benign for the consumer as what a16z portrays it there.)
- totalZero 5y ago
  They're obligated by the regulators to ensure best execution, which typically means they have to do statistical analysis of the execution quality. Routing an order away doesn't absolve them of this requirement. However, they have a business incentive to optimize for the greatest kickback. So it's a question of ethics. And those are sometimes in short supply in the financial industry.
TekMol 5y ago
This does not make sense to me. If bridging the "time divide" is a profitable business, why is it not done by normal market participants? Instead of becoming a "market maker", why don't these players just go on the open market, buy shares and hold them until "demand surfaces" and sell them? The business model which a16z describes seems no different from what every investor does. Except that the "market makers" get an unfair advantage. I doubt that this is for the better of the market. It seems like the only difference it makes to an open market is that some money is sucked out by these players because they get leverage over the other market participants.
- nly 5y ago
  Investment: Buying a car because it'll help you reach a higher paying job further away. Speculation: Buying a limited edition or already antique car, and never using it, because you believe someone else in the long future will want it more because its rare. Trading: Buying a car today to sell in the next weeks because you have better information/trading connections/higher volume than the original seller and can source a better price, or you have the distribution channels to move it cheaply and take advantage of smaller profit margins in other areas.
matteotom 5y ago
Reading this and the Bloomberg opinion piece from another commenter, it seems much of the consternation around PFOF comes from the (mis)conception that a stock has a single price at any time. In reality it has a spread between the bid and offer. PFOF (in theory) just takes advantage of inherent patterns in retail trading to both offer better pricing _and_ still make a small profit, which is shared with the broker, allowing them to offer commission free trades.
zegerjan 5y ago
As retail investor there's great downsides to market makers too. The prime example; the true price of the underlying is obscure when executing an order. Where the whole point of the market is to create price efficiency. When anyone creates a limit order in the middle of the spread it's often filled instantly, but not market moving. Other investors now do not have the same information as the market makers have who filled the order. So either they should publicly log each trade so all brokers can show what the true last price was and change in positions with that, or PFOF creates information dissymmetry. Markets should be transparent, and if you make money through obscurity that's against what the market is for. Another problem is that market makers tend not to provide liquidity when it's most needed; when markets are most volatile and unpredictable. The GME spreads for example were very wide. When the market is very volatile they tend to increase the spreads until the market is predictable (as far as they can be) again. Effectively they're like bad insurance companies: When you need them they're nowhere to be found, when you don't they'll gladly take your money. It's for everyone involved, except ones that make money of PFOF plus the market makers, probably better to have transparent inefficiency in pricing, then have defuse pricing which in some cases might be in your favour.
- smabie 5y ago
  Public exchanges provide trade feeds so anyone can see the price of the fills.
  - toufka 5y ago
    But an increasingly large number of trades are actually done by the market makers themselves, "off exchange" or in "dark pools". And when more and more transactions are not done on "lit" exchanges, especially when systematic, this does hurt price discovery (and possibly other safe-guarding tools and analyses that come with that public and transparent data).
- pgwhalen 5y ago
  You describe two phenomena that appear to be true of every two sided market ever, namely: - One can typically get a better price than what is displayed or quoted - The price of liquidity is higher when markets are volatile While yes, nobody would argue those things are good, can't they just assumed to be the nature of markets? There doesn't appear to be anything about the micro structure of modern capital markets where HFTs thrive (stocks, some options, FX, etc.) that makes these particularly bad.
ttc7152 5y ago
This article is a high level overview of the situation and doesn't get into some of the lower level technical issues with HFT firms. Just as one example: ISO (intermarket sweep orders) are routed from brokers to the different exchange venues. HFT firms have optimized their latency to the point they can actually see an ISO order on exchangeA and quickly cancel their orders on exchangeB, exchangeC before the customers order routes to the other exchanges from the broker. This effectively amounts to phantom liquidity since the size vanishes before the trade can fully execute across all venues. There are many technical games like this that are played, and its cat and mouse game with HFT and the SEC. It would serve investors well to have a single regulated exchange where all the liquidity is concentrated. The simple idea that market makers are valuable because they provide liquidity ignores the fact they play numerous technical games which are harmful to retail investors.
camkego 5y ago
"what are the chances that at that very second, somebody else wants to buy precisely 273 shares of Facebook stock? Probably zero" This is likely provably false. If you check the order books of Facebook, you almost certainly find buyers of Facebook during market hours that are not market makers. Would the spread be greater than 1 cent without the market markets, sure, but this statement is likely incorrect. And many orders can be filled partially.

67 points by alihm 5y ago

PaulHoule 5y ago

Trouble is the NBBO is not really the best price you could get.

nuclearnice3 5y ago
What is really the best price you could get?
- gruez 5y ago
  other market-makers/HFTs
TacticalCoder 5y ago
Well that's what the article is saying, right? > "Wholesale market makers typically provide price better than the National Best Bid/Offer"
- marketmakerx 5y ago
  The NBBO would be narrower without wholesale market makers.
  - nuclearnice3 5y ago
    What evidence or theory should lead me to believe this?
    - marketmakerx 5y ago
      The flow on the market becomes much more toxic after the uninformed retail flow is siphoned away.
      - nuclearnice3 5y ago
        Thanks! That makes sense to me. Wider prices because more dangerous orders.

al2o3cr 5y ago

"Are the xenomorphs a threat to human civilization, or a great opportunity for scientific advancement? As investors in Weyland-Utani, we're here to explain why they're the latter."

JohnJamesRambo 5y ago
I really enjoyed this.

marketmakerx 5y ago

What they ignore is that the NBBO spread is made larger by this practice. By siphoning off all the uninformed flow, leaving only the toxic flow, this then causes people to quote wide spreads on regular exchanges, making the NBBO spread larger than it otherwise would be.

evrydayhustling 5y ago
Yes, this article boils down to three pages of "it's complicated" followed by "the market makers publish stats that say they are great for retail". And as you point out, the stats cited ignore that the market makers play a big role determining the reference point against which "improvement" is measured.
ypzhang2 5y ago
Yes but if you tighten nbbo by mixing retail and institutional orders, it by definition will still be worse than the retail market maker price, so end result is worse for the consumer anyways?
- marketmakerx 5y ago
  Not by definition. If that uninformed flow is going to market, there is a good market design to encourage price competition among MMs who fight each other for time and price priority. That mechanism is obstructed under payment for flow. Under this, the MM only needs to give at or better than NBBO. The primary competition among MMs here is to pass on as much rents to brokers as possible, instead of minimizing rents in the first place. The market is also more prone to consolidation due to scale economies and informational advantages that private flow access provides. I also dispute the clean distinction between retail and institutional. Much institutional flow is just funds (e.g pension funds) that hold retail money. If they're getting maximally screwed by this, then so are their investors.
alpineidyll3 5y ago
Yeah, hiding behind second order thinking is a great defense :/ It seems a regrettably tiny fraction of people can take a step back and think about the basic amount of profit citadel makes per trade without actually serving as a counterparty for a period of time most humans can even measure. Pfof actually exists because exchanges and broker dealers are legally prohibited from doing the same thing. Citadel is just a external way of receiving this income as a kickback for the likes of RH.

protoax 5y ago

Struggling to see why this should be taken in any way seriously considering the clear conflict of interest?

naveen99 5y ago
Clear conflicts of interest are usually fine. It’s the unclear or hidden ones that are sometimes problematic. I mean judges trust lawyers to argue cases on behalf of their clients with a declared conflict of interest to opposing counsel.
nsonha 5y ago
just read it and see if it makes sense, if you are not confident to form an opinion, there is always the option not to.
kragen 5y ago
Because it explains how equities markets work, mostly correctly, and this is background knowledge you need if you are buying or selling equities or forming opinions about capitalism or things like "clear conflict[s] of interest".
lordnacho 5y ago
Suppose you become knowledgeable about some area. You find there is an investment opportunity, so you invest. You tell your friends about it. Should they discount your knowledge because you've acted on it? I happen to disagree with the article, but I didn't dismiss it just because it was written by someone with an interest. Quite a lot of opinion about things in the world is written by informed people who have an interest in one side or another. You can read critically and decide which parts make sense to you and which do not.
throw0101a 5y ago
> considering the clear conflict of interest? Because: > You judged something as either good or bad on the basis of where it comes from, or from whom it came. > This fallacy avoids the argument by shifting focus onto something's or someone's origins. It's similar to an ad hominem fallacy in that it leverages existing negative perceptions to make someone's argument look bad, without actually presenting a case for why the argument itself lacks merit. * https://yourlogicalfallacyis.com/genetic https://yourlogicalfallacyis.com/genetic

kilna 5y ago

"In the wake of the GameStop short squeeze" Riiiiiiight.

kingTug 5y ago

Were short positions that caused the GameStop frenzy closed or not? I can never come up with an answer when I go looking for evidence.

gregoryjjb 5y ago
They were mostly closed prior to the huge price spike, the spike was caused by retail buying, probably thinking they were causing a squeeze. You can read the details in the SEC report on the topic (note the massive drop in short interest in Figure 5). https://www.sec.gov/files/staff-report-equity-options-market-struction-conditions-early-2021.pdf https://www.sec.gov/files/staff-report-equity-options-market...
- tartoran 5y ago
  Doesn’t closing positions cause a price spike in the first place? It seems to me that they kicked the can down the road waiting for a better opportunity to do so.
  - gregoryjjb 5y ago
    It did cause some price spiking, but the FOMO caused a much bigger spike and eclipsed the effects of the squeeze. Why do you think they "kicked the can down the road"? Short interest is still around 1%, down from over 100% in January. The hedge funds in question realized huge losses in Q1.
jimmydorry 5y ago
From the SEC report: >By the end of January 2021, some funds had closed out their short positions in meme stocks, realizing significant losses. 62 In contrast, some funds that were long GME saw significant gains.63 Some investors that had been invested in the target stocks prior to the market events benefitted unexpectedly from the price rises,64 while others, including quantitative and high-frequency hedge funds, joined the market rally to trade profitably.65 Staff believes that hedge funds broadly were not significantly affected by investments in GME and other meme stocks. Staff did not observe that any advisers to private funds and registered funds experienced liquidity issues or difficulties with counterparties. Their sources for this are various news articles that were told this by hedge funds or anonymous sources. It is mentioned somewhere in the report that the SEC does not have the data or capability of detecting naked shorting. All we can know is that the short positions definitely existed at one point, but that's about it. >GME short interest hit 50% of shares outstanding first in 2012 and then again in 2015, 2016, and 2018, before rising even further in 2019. From then until early 2021, GME short interest hovered around 100%, hitting its high of 109.26% on December 31, 2020. https://www.sec.gov/files/staff-report-equity-options-market-struction-conditions-early-2021.pdf https://www.sec.gov/files/staff-report-equity-options-market...

cletus 5y ago

First strange thing: this post just mentions GameStop and leaves that hanging in the air without explanation. I assume this is because of the sale of order flow at Ronbinhood in particular but it still seems odd. Second, the real estate thing is a weird tangent. I just don't buy that adding an intermediary to real estate transactions is the win-win-win claimed. This seems like a weird detour to justify Opendoor (which, it should be noted, A16Z was an investor in). Let me use this as an analogy though. Imagine the NBBO-equivalent for house sales was a 10% broker fee split between buyer's broker and seller's broker. What this post is arguing is that the sale of order flow is fine because most people pay less than 10% this way. Thing is, once you decide to buy or sell that house, you're doing so without necessarily knowing what the price will be or how much commission you'll pay other than "probably less than 10%". Whoever is processing that is free to take that buy or sell order and then act before processing it. In financial markets, this is called frontrunning. Some markets allow it, some don't. Worse, you as an investor have less visibility into what's going on because these trades through a variety of different brokerages or exchanges can essentially occur off-market. So I'm not buying whatever this is selling. Side note: I honestly don't understand the popularity of Robinhood. It's amazing how willing many on HN are to castigate ad-supported models and the sale of user data while seemingly at the same time being completely fine with the sale of their order flow.

djbusby 5y ago
Robinhood is fun! Really. Like, compared to IB, TD or Fidelity it's FUN. And game-ified so it had a cute ding when you get a green up arrow! A Skinner Box for your money management. Humans (and rats) love to press the lever to get the reward.
- hckrnrd 5y ago
  I wholeheartedly agree. Compared to ToS and IB, RH makes derivative gambling a blast. At least the platform calls a spade a spade—it’s not for the boggle heads, but rather for those interested in taking on risk. And if your investment time horizon is measured in decades, instead of years, it makes perfect sense to me.
5y ago

IAmGraydon 5y ago

I have a problem with any article that starts off by making a false statement in the first sentence. GME was not a short squeeze. The SEC did a very detailed analysis, which was released recently, and it’s pretty cut and dry - GME went up because of a massive number of retail traders buying the underlying. Short covering contributed very little to the upward momentum.

garmaine 5y ago
That is splitting hairs to avoid reality. WSB found an over-subscribed short position and exploited it. But because this happened in public, A LOT of people piled on. So in the end the main thing moving the price was the WSB hype, but the squeeze was still there. It was the trigger that made everything else happen.
- IAmGraydon 5y ago
  No, it wasn’t. Read the report.
  - clove 5y ago
    You don't need to read the report if you're familiar with the stock. I've been following the stock for several years, and before WSB it has been undervalued, pushing penny stock level despite being a ~10-20 dollar stock in terms of DCF. Short interest on GME has been around 100% for years now, and surpassed 100% prior to the WSB stuff. Why do you trust the SEC more than short interest numbers?
  - sonotathrowaway 5y ago
    This is the report: 3.4 Short Selling and Covering Short Positions GameStop at the time was notable for its significant short interest (the ratio of shares currently sold short to shares outstanding).74 Figure 5 shows GME’s short interest over time, along with average levels of short interest among other non-financial common stocks. In the past, GME had several periods of high short interest, but none as high as the levels achieved from 2019 to mid-January 2021. GME short interest hit 50% of shares outstanding first in 2012 and then again in 2015, 2016, and 2018, before rising even further in 2019. From then until early 2021, GME short interest hovered around 100%, hitting its high of 109.26% on December 31, 2020. Some commentators have asked how short interest can get as high as it did in GameStop. Short interest can exceed 100%—as it did with GME—when the same shares are lent multiple times by successive purchasers. If someone purchases a stock from a short seller and subsequently lends the stock out again, it will appear as if the stock was sold short twice for the purpose of the short interest calculation.75 Short interest ratios tend to be quite low; for large non-financial stocks, they are often less than 2.5% whereas for small non-financial stocks they still tend to be less than 13%. Few stocks, if any, have short interest greater than 50% on a given date.76 Until recently, short interest of more than 90% was observed only a few times—in 2007 and 2008. When examining short interest as a percent of shares outstanding, GME is the only stock that staff observed as having short interest of more than shares outstanding in January 2021. What’s the difference between a short squeeze and short sellers are buying to close their positions 2021, GME short interest hovered around 100%, hitting its high of 109.26% on December 31, 2020. Some commentators have asked how short interest can get as high as it did in GameStop. Short interest can exceed 100%—as it did with GME—when the same shares are lent multiple times by successive purchasers. If someone purchases a stock from a short seller and subsequently lends the stock out again, it will appear as if the stock was sold short twice for the purpose of the short interest calculation.75 Short interest ratios tend to be quite low; for large non-financial stocks, they are often less than 2.5% whereas for small non-financial stocks they still tend to be less than 13%. Few stocks, if any, have short interest greater than 50% on a given date.76 Until recently, short interest of more than 90% was observed only a few times—in 2007 and 2008. When examining short interest as a percent of shares outstanding, GME is the only stock that staff observed as having short interest of more than shares outstanding in January 2021.

Negitivefrags 5y ago

Since everyone in this thread seems determined to dismiss this take entirely due to who is saying it, perhaps people would prefer this article by Matt Lavine explaining much the same thing? https://www.bloomberg.com/opinion/articles/2021-02-05/robinhood-gamestop-saga-pressures-payment-for-order-flow https://www.bloomberg.com/opinion/articles/2021-02-05/robinh... Hint: PFOF is fine.

unmole 5y ago
You want me to take a Goldman Sachs alum's word when he says whatever Wall Street is doing to retail investors is fine? /s
camgunz 5y ago
From that article: > Now of course I am oversimplifying. For one thing, the wholesalers don’t have to fill every order out of inventory; they will do that with some orders and pass others on to the exchange to execute. They do not provide price improvement on 100% of orders, though they do compete to provide price improvement and are evaluated by brokers based on how much they provide. They will often lay off risk on the public markets rather than trading exclusively with retail customers; often they will be in the business of market making on the exchanges too, and will manage that business and the retail business in some interacting way. Anyone who trades a lot of stock benefits from having information about order flow, and a wholesaler who sees a lot of retail orders will have some informational advantages in its public trading. Or TL;DR: the NBBO benefit pointed to by OP isn't absolute, order flow is valuable information, and rather than being some kind of exchange utility wholesalers are actually trying to maximize their own profits. I'm fine with this? I'm not fine with how OP characterizes them, which doesn't seem aligned.
- smabie 5y ago
  Of course market makers are trying to maximize profit: they are trading firms just like any others. However, retail order flow is (pretty much by definition) not particularly valuable information: if it was, wholesalers would be unwilling to consistently take the other side at such good prices. Of course order flow in general is highly valuable information, it's just that retail order flow isn't because it's very non-toxic (there is little to no predictive signal in the flow).

sushsjsuauahab 5y ago

What does the world gain from finance? I am a bit confused. Seems to me that the only important things are assets, labor, and sometimes a medium of exchange. Just because I have a mortgage and a credit card doesn't mean I can't survive without them. Now that we have computers, most of us are actually and literally creating something out of nothing.

pgwhalen 5y ago
Finance allocates capital and moves risk from parties who don't want it towards parties who do want it. > Just because I have a mortgage and a credit card doesn't mean I can't survive without them. You could definitely survey without them, the same way you could survive without a car or a smartphone. A mortgage in particular is undeniably useful for many people.
- sushsjsuauahab 5y ago
  Only because housing prices have been artificially inflated? I can prove how they are, but curious to know if you agree they are. Finance is a bandaid for deeper issues.
  - icebraining 5y ago
    Only because they have been artificially inflated? That seems unlikely; the materials and labor costs alone would take multiple years to pay off by an average family. Being able to move in immediately seems useful, even if currently we're paying way too much for it.
  - smabie 5y ago
    I mean finance has existed for thousands of years. What are these deeper issues? Whatever they are it seems unlikely they are ever going away.
FabHK 5y ago
> What does the world gain from finance? Not sure whether you're asking seriously, but while there is a lot of scamming and rent seeking in finance (which is why it is subject to heavy regulation), it does provide many functions: 1. transfer of purchasing power through time (by saving/credit) 2. proper valuation 3. facilitation of investments (for companies, infrastructure, etc.) 4. investment allocation 5. risk transfer and management etc. All valuable functions. > most of us are actually and literally creating something out of nothing Your labour and your computer and the electricity used to run that computer etc. are not nothing. The economy has always been about creating something more valuable out of inputs that are less valuable. Nothing new here.

FabHK 5y ago

> Retail brokers typically route orders to a handful of market makers, allocating more to the market makers that provide the highest amount of price improvement to the retail investors. Do they? Or would they typically allocate more to the market makers that pay them the largest kick-back ("payment for order flow")? (Not that that is inherently wrong, but it is not quite as benign for the consumer as what a16z portrays it there.)

totalZero 5y ago
They're obligated by the regulators to ensure best execution, which typically means they have to do statistical analysis of the execution quality. Routing an order away doesn't absolve them of this requirement. However, they have a business incentive to optimize for the greatest kickback. So it's a question of ethics. And those are sometimes in short supply in the financial industry.

TekMol 5y ago

This does not make sense to me. If bridging the "time divide" is a profitable business, why is it not done by normal market participants? Instead of becoming a "market maker", why don't these players just go on the open market, buy shares and hold them until "demand surfaces" and sell them? The business model which a16z describes seems no different from what every investor does. Except that the "market makers" get an unfair advantage. I doubt that this is for the better of the market. It seems like the only difference it makes to an open market is that some money is sucked out by these players because they get leverage over the other market participants.

nly 5y ago
Investment: Buying a car because it'll help you reach a higher paying job further away. Speculation: Buying a limited edition or already antique car, and never using it, because you believe someone else in the long future will want it more because its rare. Trading: Buying a car today to sell in the next weeks because you have better information/trading connections/higher volume than the original seller and can source a better price, or you have the distribution channels to move it cheaply and take advantage of smaller profit margins in other areas.

matteotom 5y ago

Reading this and the Bloomberg opinion piece from another commenter, it seems much of the consternation around PFOF comes from the (mis)conception that a stock has a single price at any time. In reality it has a spread between the bid and offer. PFOF (in theory) just takes advantage of inherent patterns in retail trading to both offer better pricing _and_ still make a small profit, which is shared with the broker, allowing them to offer commission free trades.

zegerjan 5y ago

As retail investor there's great downsides to market makers too. The prime example; the true price of the underlying is obscure when executing an order. Where the whole point of the market is to create price efficiency. When anyone creates a limit order in the middle of the spread it's often filled instantly, but not market moving. Other investors now do not have the same information as the market makers have who filled the order. So either they should publicly log each trade so all brokers can show what the true last price was and change in positions with that, or PFOF creates information dissymmetry. Markets should be transparent, and if you make money through obscurity that's against what the market is for. Another problem is that market makers tend not to provide liquidity when it's most needed; when markets are most volatile and unpredictable. The GME spreads for example were very wide. When the market is very volatile they tend to increase the spreads until the market is predictable (as far as they can be) again. Effectively they're like bad insurance companies: When you need them they're nowhere to be found, when you don't they'll gladly take your money. It's for everyone involved, except ones that make money of PFOF plus the market makers, probably better to have transparent inefficiency in pricing, then have defuse pricing which in some cases might be in your favour.

smabie 5y ago
Public exchanges provide trade feeds so anyone can see the price of the fills.
- toufka 5y ago
  But an increasingly large number of trades are actually done by the market makers themselves, "off exchange" or in "dark pools". And when more and more transactions are not done on "lit" exchanges, especially when systematic, this does hurt price discovery (and possibly other safe-guarding tools and analyses that come with that public and transparent data).
pgwhalen 5y ago
You describe two phenomena that appear to be true of every two sided market ever, namely: - One can typically get a better price than what is displayed or quoted - The price of liquidity is higher when markets are volatile While yes, nobody would argue those things are good, can't they just assumed to be the nature of markets? There doesn't appear to be anything about the micro structure of modern capital markets where HFTs thrive (stocks, some options, FX, etc.) that makes these particularly bad.

ttc7152 5y ago

This article is a high level overview of the situation and doesn't get into some of the lower level technical issues with HFT firms. Just as one example: ISO (intermarket sweep orders) are routed from brokers to the different exchange venues. HFT firms have optimized their latency to the point they can actually see an ISO order on exchangeA and quickly cancel their orders on exchangeB, exchangeC before the customers order routes to the other exchanges from the broker. This effectively amounts to phantom liquidity since the size vanishes before the trade can fully execute across all venues. There are many technical games like this that are played, and its cat and mouse game with HFT and the SEC. It would serve investors well to have a single regulated exchange where all the liquidity is concentrated. The simple idea that market makers are valuable because they provide liquidity ignores the fact they play numerous technical games which are harmful to retail investors.

camkego 5y ago

"what are the chances that at that very second, somebody else wants to buy precisely 273 shares of Facebook stock? Probably zero" This is likely provably false. If you check the order books of Facebook, you almost certainly find buyers of Facebook during market hours that are not market makers. Would the spread be greater than 1 cent without the market markets, sure, but this statement is likely incorrect. And many orders can be filled partially.