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The first thing I did was open the article and search for PFOF (Payment for Order Flow). > This proposal would address a controversial practice called payment

by CSSer 4y ago

The first thing I did was open the article and search for PFOF (Payment for Order Flow). > This proposal would address a controversial practice called payment for order flow, in which some brokers collect rebates for sending customers’ orders to wholesalers. Mr. Gensler has called the practice a conflict of interest and, in past statements, left open the possibility of banning it. The SEC’s best-execution proposal doesn’t go that far. But it imposes additional obligations on brokers that engage in payment for order flow to help ensure that customers are getting a good deal. Shame. They’re skimming money straight off the top. Perhaps I should withhold judgment but I suspect they’re banking on the idea that Joe Schmoe, who downloaded an app to gamble with his future, isn’t going to seek out this financial disclosure data. I have a friend who can rattle off everything there is to know about option spreads and general technical analysis drivel. He initially didn’t believe me when I told him about PFOF.

tptacek 4y ago
Who's skimming off money where now?
- CSSer 4y ago
  Institutional investors. I can’t explain it better than Matt Levine’s article. It’s well worth the read, and it links directly to the SEC proposal if you’d like to read deeper from there. After reading the article, my take is less harsh. It is really bizarre to me why instead of outright banning it, they just want to make it a really bad deal to do so. But if it works, great! We’ll see.
  - tptacek 4y ago
    Levine doesn't believe PFOF involves people skimming money from retail investors, if that's what you're implying. Levine's story boils down to: retail order flow is cheaper to make markets for, wholesalers and brokers can split the savings three ways (between retail investors, the broker [via PFOF], and the wholesaler). That's not skimming; that's, like, the operating principle of Walmart.
    - vgatherps 4y ago
      There's an argument that it artificially increases spreads in lit markets, since you have segregated the least toxic flow to only go to a few select players (largely Citadel and Virtu). Further, these increased spreads mean that the 'price improvement' is only price-improved against a spread that's being quoted against only the most toxic flow. However, many spreads are still close to a single tick, although this is less true as individual ticker prices have generally gotten higher. The tick size changes are interesting as well in the context of auctions. If a claim is "you can't have an auction with sub-penny pricing so there's no improvement", well then make the tick size smaller.
      - TOR_USER_01 4y ago
        Another argument against PFOF is that brokers could (and Robinhood has been caught doing it) be incentivized to route orders to the highest PFOF rather than executing at the best real price.
      - adrr 4y ago
        As a retail investor, I’d rather have PFOF and free trading instead of paying $5 to $10 a trade which is more expensive than spread improvements. That’s what PFOF has brought to retail investors. It’s not like retail investors was ever put onto the public exchanges prior to robinhood and PFOF, they were sent to dark pools for institutional investors to trade against but retail investor never got the benefit.
        vgatherps 4y ago
        PFOF isn't gigantic revenue driver for many retail brokerages, including some that offer zero commission trading (like Schwab). Robinhood may have started the price war while making most of its money from PFOF, but you can have low to zero commission trading without PFOF. The payments per share tend to be extremely small - on most symbols the broker isn't making $5-10 per trade from the MM, for reasonably sized trades. Even if payment for flow was costing you that much, paying for an order vs giving more price improvement are indistinguishable. Payment for order flow just means that price improvement definitely goes to the broker instead of back to you.
rocqua 4y ago
PFOF is not a problem, except that it hurts your pension funds. PFOF needs to be price improvement. Research has been done and it _does_ give price improvement. The main point of PFOF is that high frequency traders have much less risk when trading with single persons than they do trading with big players. They are willing to offer them much better prices than they will offer big players. Suppose there is 10cents difference. PFOF means they pay your broker, say 5c to give you a 5c better price. You are better off, your broker is better off, the high frequency traders are better off. The only people worse off are the big players. Because when HFTs can filter out the low risk trades, the high risk trades get more expensive for them. Research has been done showing that different brokers split the price advantage differently. Robin hood, IIRC was one the worse side, allocating 80% of price advantage to PFOF, leaving only 20% to the customer. But the customer is still better off than paying the public exchange rate. ----------------------------- The above was written before I found this report: https://www.afm.nl/~/profmedia/files/nieuws/2022/afm-paper-assessment-execution-quality-pfof-venues.pdf https://www.afm.nl/~/profmedia/files/nieuws/2022/afm-paper-a... I found it trying to find the source for the research I quote. That stat came from Matt Levine's newsletter. This report contradicts what I wrote above. It does seem that the report is about european brokers, whilst Matt Levine was talking about US brokers. edit: I believe this is the orginal source regarding US markets: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4189239 https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4189239
- cool_dude85 4y ago
  >Research has been done showing that different brokers split the price advantage differently. Robin hood, IIRC was one the worse side, allocating 80% of price advantage to PFOF, leaving only 20% to the customer. But the customer is still better off than paying the public exchange rate. But why should Robinhood or whoever else get part of the 10 cents that the algo is offering me, the little ol' retail investor? Just because they're in position to gobble some of it up without me knowing?
  - thefreeman 4y ago
    Because they built the app you are trading on, made the agreements with the HFT, and are facilitating the trade?

by CSSer 4y ago

tptacek 4y ago

Who's skimming off money where now?

CSSer 4y ago
Institutional investors. I can’t explain it better than Matt Levine’s article. It’s well worth the read, and it links directly to the SEC proposal if you’d like to read deeper from there. After reading the article, my take is less harsh. It is really bizarre to me why instead of outright banning it, they just want to make it a really bad deal to do so. But if it works, great! We’ll see.
- tptacek 4y ago
  Levine doesn't believe PFOF involves people skimming money from retail investors, if that's what you're implying. Levine's story boils down to: retail order flow is cheaper to make markets for, wholesalers and brokers can split the savings three ways (between retail investors, the broker [via PFOF], and the wholesaler). That's not skimming; that's, like, the operating principle of Walmart.
  - vgatherps 4y ago
    There's an argument that it artificially increases spreads in lit markets, since you have segregated the least toxic flow to only go to a few select players (largely Citadel and Virtu). Further, these increased spreads mean that the 'price improvement' is only price-improved against a spread that's being quoted against only the most toxic flow. However, many spreads are still close to a single tick, although this is less true as individual ticker prices have generally gotten higher. The tick size changes are interesting as well in the context of auctions. If a claim is "you can't have an auction with sub-penny pricing so there's no improvement", well then make the tick size smaller.
    - TOR_USER_01 4y ago
      Another argument against PFOF is that brokers could (and Robinhood has been caught doing it) be incentivized to route orders to the highest PFOF rather than executing at the best real price.
    - adrr 4y ago
      As a retail investor, I’d rather have PFOF and free trading instead of paying $5 to $10 a trade which is more expensive than spread improvements. That’s what PFOF has brought to retail investors. It’s not like retail investors was ever put onto the public exchanges prior to robinhood and PFOF, they were sent to dark pools for institutional investors to trade against but retail investor never got the benefit.
      - vgatherps 4y ago
        PFOF isn't gigantic revenue driver for many retail brokerages, including some that offer zero commission trading (like Schwab). Robinhood may have started the price war while making most of its money from PFOF, but you can have low to zero commission trading without PFOF. The payments per share tend to be extremely small - on most symbols the broker isn't making $5-10 per trade from the MM, for reasonably sized trades. Even if payment for flow was costing you that much, paying for an order vs giving more price improvement are indistinguishable. Payment for order flow just means that price improvement definitely goes to the broker instead of back to you.

rocqua 4y ago

PFOF is not a problem, except that it hurts your pension funds. PFOF needs to be price improvement. Research has been done and it _does_ give price improvement. The main point of PFOF is that high frequency traders have much less risk when trading with single persons than they do trading with big players. They are willing to offer them much better prices than they will offer big players. Suppose there is 10cents difference. PFOF means they pay your broker, say 5c to give you a 5c better price. You are better off, your broker is better off, the high frequency traders are better off. The only people worse off are the big players. Because when HFTs can filter out the low risk trades, the high risk trades get more expensive for them. Research has been done showing that different brokers split the price advantage differently. Robin hood, IIRC was one the worse side, allocating 80% of price advantage to PFOF, leaving only 20% to the customer. But the customer is still better off than paying the public exchange rate. ----------------------------- The above was written before I found this report: https://www.afm.nl/~/profmedia/files/nieuws/2022/afm-paper-assessment-execution-quality-pfof-venues.pdf https://www.afm.nl/~/profmedia/files/nieuws/2022/afm-paper-a... I found it trying to find the source for the research I quote. That stat came from Matt Levine's newsletter. This report contradicts what I wrote above. It does seem that the report is about european brokers, whilst Matt Levine was talking about US brokers. edit: I believe this is the orginal source regarding US markets: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4189239 https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4189239

cool_dude85 4y ago
>Research has been done showing that different brokers split the price advantage differently. Robin hood, IIRC was one the worse side, allocating 80% of price advantage to PFOF, leaving only 20% to the customer. But the customer is still better off than paying the public exchange rate. But why should Robinhood or whoever else get part of the 10 cents that the algo is offering me, the little ol' retail investor? Just because they're in position to gobble some of it up without me knowing?
- thefreeman 4y ago
  Because they built the app you are trading on, made the agreements with the HFT, and are facilitating the trade?