4 ms·

Could you elaborate on what's wrong with payment for order flow? It seems to enable zero commission brokers with prices (bid-ask spreads) that are reasonable, a

by FabHK 4y ago

Could you elaborate on what's wrong with payment for order flow? It seems to enable zero commission brokers with prices (bid-ask spreads) that are reasonable, and at any rate better than the national best bid offer, as required by law.

pclmulqdq 4y ago
PFOF allows market participants to selectively hide information that was historically important for stock prices (retail demand) from the rest of the market, which may result in larger spreads due to price uncertainty. The other side of the zero commissions is that retail investors are almost certainly paying for larger spreads than they would otherwise get on the open market (if not, buying order flow wouldn't be worth it for order flow buyers). As an example, I once A/B tested interactive brokers vs robinhood on their execution quality. With notional volumes of a few thousand dollars per trade, the IB commission was very much worth it compared to the poor execution quality from RH. The issue is that many consumers don't understand that a free brokerage can actually be more expensive for them than a more expensive brokerage.
- unmole 4y ago
  > The other side of the zero commissions is that retail investors are almost certainly paying for larger spreads than they would otherwise get on the open market All brokers are obligated to fill orders within the National Best Bid Offer spread. A retail trader can't get a better price on the open market. > As an example, I once A/B tested interactive brokers vs robinhood on their execution quality. IB sells retail orders to market makers too. This has more to do with Robinhood being awful than with PFOF being detrimental by itself.
  - pclmulqdq 4y ago
    You actually can get a better price on the open market. There are often traders in dark pools offering better prices than the NBBO and there are things like iceberg orders that do not affect the NBBO but do allow you to trade at a price inside the NBBO. All that means that transferring your order to a public forum will often get a price better than the NBBO. Also, IB tells you where your orders go - you can see if they went to a PFOF vendor or some other venue. You can also decide where to route your order, although this costs a bit of money.
    - FabHK 4y ago
      Good points. However, wouldn't it be fair to say that the underlying problem is not PFOF (which does seem to benefit small retail customers), but market microstructure, and specifically the issue of order routing, and that there is not one market place, but many (many of which are "dark")? If I were to design markets, I'd seriously consider: - obligation to trade on one central exchange - a Tobin tax (ie a minuscule tax on all transactions) - not continuous trading with a LOB, but an auction approximately every 5 minutes or so with stochastic cutoff time
      - pclmulqdq 4y ago
        The central exchange idea might make sense, but exchanges themselves are a business. Creating a central one is tantamount to mandating a monopoly, which doesn't often result in good things. If I were the SEC, I would do the following: * Remove reg NMS as it applies to brokers and broker-dealers, allowing them to trade anywhere they want. Keep the requirement that brokers must give a price to customers at or better than the NBBO (but let them trade how they want on the exchanges). This should make brokerage fees cheaper and reduce spreads. * Require brokers to provide execution quality reports to the public the way that brokerage fees are reported to the public. Brokers would then have to say: "$0 commissions, 0.1% average spreads" or something along those lines. The market for high-fee high-quality brokers would likely develop around that: "$5 commissions, 0.01% spreads" is compelling to people who trade large blocks. Hedge funds and big money traders already test brokers like this. * Allow and/or require crossing auctions for retail market orders that get to an exchange. Privileging retail orders on exchange and having brokerages advertise their slippage should give "high-commission, low-spread" brokerages the incentive to send most customer orders to an exchange, and a mechanism to get the best possible price from the broader market. Also, a tiny Tobin tax does currently exist - it funds the SEC. However, adding higher transaction taxes has been tried in Europe, and turned some exchanges into wastelands.
  - FabHK 4y ago
    The stylised facts seem to be that historically, brokers would charge a commission, receive PFOF, and give a large chunk of that PFOF back to the customer in the form of a better price (smaller spread). Robinhood then did away with the commission, but pocketed the PFOF, offering consumers a worse price. Thus: retail consumers with very small orders would be better off at Robinhood, but with even orders of a few thousand dollars it would have been advantageous to go with a small fixed fee, but execute with a better price. (Note that all of the above is within the NBBO, but that is not a tight benchmark, apparently.)
- skybrian 4y ago
  As I understand it, they're paying to trade with people who probably have their own reasons for trading that have nothing to do with any market-changing news. They want to trade with "random" traders, not sharks. It's not obvious why this would result in larger spreads. The reason for it is to be able to offer smaller spreads due to lower risk.
- listenallyall 4y ago
  > a free brokerage can actually be more expensive for them than a more expensive brokerage. I agree with this comment, my question is whether anyone is obligated to inform people of this. If you are an adult and have the resources to be investing in stocks, you ought to at least recognize that nothing in life is "free."
  - pclmulqdq 4y ago
    Nobody is obligated to inform you. I think a lot of people expected that free brokerage was the same trade as Facebook and Google - data for services. It's not.

by FabHK 4y ago

pclmulqdq 4y ago

PFOF allows market participants to selectively hide information that was historically important for stock prices (retail demand) from the rest of the market, which may result in larger spreads due to price uncertainty. The other side of the zero commissions is that retail investors are almost certainly paying for larger spreads than they would otherwise get on the open market (if not, buying order flow wouldn't be worth it for order flow buyers). As an example, I once A/B tested interactive brokers vs robinhood on their execution quality. With notional volumes of a few thousand dollars per trade, the IB commission was very much worth it compared to the poor execution quality from RH. The issue is that many consumers don't understand that a free brokerage can actually be more expensive for them than a more expensive brokerage.

unmole 4y ago
> The other side of the zero commissions is that retail investors are almost certainly paying for larger spreads than they would otherwise get on the open market All brokers are obligated to fill orders within the National Best Bid Offer spread. A retail trader can't get a better price on the open market. > As an example, I once A/B tested interactive brokers vs robinhood on their execution quality. IB sells retail orders to market makers too. This has more to do with Robinhood being awful than with PFOF being detrimental by itself.
- pclmulqdq 4y ago
  You actually can get a better price on the open market. There are often traders in dark pools offering better prices than the NBBO and there are things like iceberg orders that do not affect the NBBO but do allow you to trade at a price inside the NBBO. All that means that transferring your order to a public forum will often get a price better than the NBBO. Also, IB tells you where your orders go - you can see if they went to a PFOF vendor or some other venue. You can also decide where to route your order, although this costs a bit of money.
  - FabHK 4y ago
    Good points. However, wouldn't it be fair to say that the underlying problem is not PFOF (which does seem to benefit small retail customers), but market microstructure, and specifically the issue of order routing, and that there is not one market place, but many (many of which are "dark")? If I were to design markets, I'd seriously consider: - obligation to trade on one central exchange - a Tobin tax (ie a minuscule tax on all transactions) - not continuous trading with a LOB, but an auction approximately every 5 minutes or so with stochastic cutoff time
    - pclmulqdq 4y ago
      The central exchange idea might make sense, but exchanges themselves are a business. Creating a central one is tantamount to mandating a monopoly, which doesn't often result in good things. If I were the SEC, I would do the following: * Remove reg NMS as it applies to brokers and broker-dealers, allowing them to trade anywhere they want. Keep the requirement that brokers must give a price to customers at or better than the NBBO (but let them trade how they want on the exchanges). This should make brokerage fees cheaper and reduce spreads. * Require brokers to provide execution quality reports to the public the way that brokerage fees are reported to the public. Brokers would then have to say: "$0 commissions, 0.1% average spreads" or something along those lines. The market for high-fee high-quality brokers would likely develop around that: "$5 commissions, 0.01% spreads" is compelling to people who trade large blocks. Hedge funds and big money traders already test brokers like this. * Allow and/or require crossing auctions for retail market orders that get to an exchange. Privileging retail orders on exchange and having brokerages advertise their slippage should give "high-commission, low-spread" brokerages the incentive to send most customer orders to an exchange, and a mechanism to get the best possible price from the broader market. Also, a tiny Tobin tax does currently exist - it funds the SEC. However, adding higher transaction taxes has been tried in Europe, and turned some exchanges into wastelands.
- FabHK 4y ago
  The stylised facts seem to be that historically, brokers would charge a commission, receive PFOF, and give a large chunk of that PFOF back to the customer in the form of a better price (smaller spread). Robinhood then did away with the commission, but pocketed the PFOF, offering consumers a worse price. Thus: retail consumers with very small orders would be better off at Robinhood, but with even orders of a few thousand dollars it would have been advantageous to go with a small fixed fee, but execute with a better price. (Note that all of the above is within the NBBO, but that is not a tight benchmark, apparently.)
skybrian 4y ago
As I understand it, they're paying to trade with people who probably have their own reasons for trading that have nothing to do with any market-changing news. They want to trade with "random" traders, not sharks. It's not obvious why this would result in larger spreads. The reason for it is to be able to offer smaller spreads due to lower risk.
listenallyall 4y ago
> a free brokerage can actually be more expensive for them than a more expensive brokerage. I agree with this comment, my question is whether anyone is obligated to inform people of this. If you are an adult and have the resources to be investing in stocks, you ought to at least recognize that nothing in life is "free."
- pclmulqdq 4y ago
  Nobody is obligated to inform you. I think a lot of people expected that free brokerage was the same trade as Facebook and Google - data for services. It's not.