6 ms·

Pfof is woefully misunderstood In general, citadel wants to pay to trade with retail investors because it knows it isn't going to face adverse selection. So it

by wrsh07 2y ago

Pfof is woefully misunderstood In general, citadel wants to pay to trade with retail investors because it knows it isn't going to face adverse selection. So it will give them tighter bid/ask ratios (this is better for the customer) than they would get if they were trading in the open market, citadel isn't going to get hosed by one of them (because there's no adverse selection) It's win win win

wrsh07 2y ago
Here's the money stuff excerpt: https://marginalrevolution.com/marginalrevolution/2021/02/the-wisdom-of-matt-levine-payment-for-order-flow.html https://marginalrevolution.com/marginalrevolution/2021/02/th... > I feel like most of what I read about payment for order flow is insane? Otherwise normal people will start out mainstream explainer articles by saying, like, “Robinhood sells your order to Citadel so Citadel can front-run it.” No! First of all, it is illegal to front-run your order, and the Securities and Exchange Commission does, you know, keep an eye on this stuff. Second, the wholesaler is ordinarily filling your order at a price that is better than what’s available in the public market, so “front-running”—going out and buying on the stock exchange and then turning around and selling to you at a profit—doesn’t work. Third, because retail orders are generally uninformative, the wholesaler is not rubbing its hands together being like “bwahahaha now I know that Matt Levine is buying GameStop, it will definitely go up, I must buy a ton of it before he gets any!” The whole story is widely accepted but also completely transparent nonsense.
- 1oooqooq 2y ago
  it's already public that frontrunning is perfectly legal if you can do it with large volume as to not show intent of frontrunning one single person.
  - slt2021 2y ago
    yeah, Citadel's annual $30,000,000,000 profit is not coming out of thin air or just from bid-ask spread. Customers are being taken for a ride definitely
- deleted 2y ago
  [deleted]
taway789aaa6 2y ago
> PFOF and excessive off-exchange trading persist because so many trading platforms rely on the revenue it generates, essentially productizing their clients. Defenders of PFOF have claimed that retail brokers who route to high-speed traders (in exchange for PFOF) provide better price execution for investors and that it’s a net positive, despite creating an inherent misalignment between these platforms and their customers, and despite public evidence to the contrary. Leaning on the flawed argument that they categorically provide retail customers with best price execution quality, there is little by way of self-regulation to foment change or prevent applications designed to optimize transaction volume (i.e. speculation and day trading) and risky activity (i.e. margin and options trading). Further, their ability to claim best execution is part of the flaw of the system, as even within the current structure better outcomes are possible on an order-by-order, and aggregated basis. https://advocacy.urvin.finance/advocacy/we-the-investors-pfof-sign-on https://advocacy.urvin.finance/advocacy/we-the-investors-pfo... Not a win win.
- gruez 2y ago
  >and despite public evidence to the contrary Sounds serious, I wonder what it is... >"410 The author deleted this Medium story". doesn't look promising. The rest of the paragraph fails to state any concrete harm, instead focusing on abstract issues like "misalignment between these platforms and their customers", and "little by way of self-regulation ".
- highwaylights 2y ago
  This. It seems very much like that bogus stat that HR departments were peddling 20 years ago about how they only hire the top X% of people because they reject (100-X)% applicants - it tells you nothing about the quality in the gap. These systems don't have to actively attempt to front-run you or pro-actively make bad trades, they can just optimize for deal flow, which is enough to cause the customer to get a sub-optimal price.
  - freeone3000 2y ago
    You’re getting a price as good or better than if you had routed it through the backing exchange directly. National Bid or Best Offer continues to be the rule.
throwacomment 2y ago
Yes, PFOF is woefully misunderstood but its very much not win win win. The reason its bad is because its anti-competive and gives them information that no-one else has access to. By trading against you, Citadel prevents any other potential market maker from trading with you. With less competition, the spread widens and even after price improvement, you're paying more. PFOF also tells them who they are trading against but anyone else who just sees a quote doesn't know that. Generally, things are very zero sum so wins all around are very unlikely. But some thinking is needed to track where the value loss and gains are.
- wrsh07 2y ago
  Please see my other comment that provides links to a study that shows: yes you get the best price from a broker using pfof Your argument seems reasonable but isn't borne out empirically https://news.ycombinator.com/item?id=42378516 https://news.ycombinator.com/item?id=42378516
  - throwacomment 2y ago
    I'm not talking about you getting a worse price today. Suppose in some other industry, some monopolist consistently sells goods at a loss to drive out all the competition. In the last moments when they are doing this, yes its cheaper for you to buy from the monopolist at that moment. But after everyone is driven out of the market, you'll be paying more. Even though the monopolist is still the cheapest amongst all options. I'm saying you're already in the "after" scenario here. You're saying that you can save a few cents with PFOF when you cross that 50 cents spread and yes that's true. But I'm saying that spread should be 25 cents and no-one is offering that because they've been driven out. Now that I think about it, the more immediate consequence to you is that some of your order will not fill because PFOF exists, rather than you getting a worst price. Say you put a bid to buy at 100. And then I come along and want to sell at 100. Normally, you'd get to buy from me. But because my order is PFOF'd, Citadel decides that buying from me at 101 is a good deal so they do. This happens a few time with different sellers then you get fed up and/or the market moves. So you raise your bid to 150. Citadel sells to you at 149. You saved 1 off that 150 but lost out 49 from the trade you'd have gotten from me without PFOF.
lldb 2y ago
It is not a win. In a recent study, Robinhood with Citadel has the worst price improvement (execution quality) of any brokerage on the market. I’ve personally observed this - Robinhood might “improve” by 1/10 of a cent from NBBO while Fidelity is frequently closer to the mid.
- loeg 2y ago
  How is that not a win? Robinhood customers still got better execution than NBBO. If you don't like Robinhood getting a tiny kickback here, you're free to go to another brokerage.
- wrsh07 2y ago
  This is just noting that different brokers give different performance That doesn't really have anything to do with pfof (TD Ameritrade gives better execution and receives pfof) https://news.ycombinator.com/item?id=42378516 https://news.ycombinator.com/item?id=42378516
  - loeg 2y ago
    Presumably a market maker would pay (PFOF) slightly more to deliver slightly worse execution (keeping the spread).
    - wrsh07 2y ago
      Sure that sounds plausible but it's literally not what happens in practice (see the other comment I linked that discusses research on this very thing)
      - loeg 2y ago
        Yeah, I've seen the Levine column on it.
neximo64 2y ago
Distorted incentives
WiSaGaN 2y ago
It's not. Centralization of liquidity is better for everyone. HFT thrives on fragmentation of liquidity. HFT is not wrong, but fragmentation of liquidity is.
- rjrdi38dbbdb 2y ago
  Nope. It's not better for known uninformed traders. If you mix them in with informed traders, market makers must widen spreads. This is very obvious in institutional FX. Pure "retail" flow will get quoted much tighter spreads by banks and market makwrs than you'll see on any ECN. Yes, it can get skweded against predictable flow, but a true "noise" trader won't be affected by that and will definitely be better off with tailored liquidity.
  - WiSaGaN 2y ago
    You don’t have to trade with market makers.
    - rjrdi38dbbdb 2y ago
      So you're hoping get price improvement by crossing with other trader orders in the book? Unless you have a good high frequency predictor and low latency order management (you don't), you're going to experience adverse selection. Either because you're taking resting orders that HFTs are smart enough to avoid or because your resting orders get run over by informed traders.
      - WiSaGaN 2y ago
        So you are saying HFT will avoid your market order in this case, while HFT will provide better price when they are the sole counter party in separate liquidity pool? HFT will always maximize profit. To have multiple venues you are just paying HFT as middle man to transfer liquidity from one to another, where you can trade directly with each other if everyone is on one venue, e.g. one centralized limit order book. Transfering liquidity is not HFT's fault, but saying paying for order flow is better for retail is just disinformation. Without evenly discussing the function of HFT, you will get disinformation that demonize HFT as well, and common people won't listen to you later.
nobodywillobsrv 2y ago
Adverse selection goes both ways. If PFOF leads to adverse selection against your flow then it's not win-win. You might say you are willing to trade of adverse selection up to the cost of the fees, but then you are trading a known fixed fee for an unknown stochastic penalty. And also who sets the fees? The entire thing is adversarial and it's really just a choice of game you choose to play.

by wrsh07 2y ago

wrsh07 2y ago

Here's the money stuff excerpt: https://marginalrevolution.com/marginalrevolution/2021/02/the-wisdom-of-matt-levine-payment-for-order-flow.html https://marginalrevolution.com/marginalrevolution/2021/02/th... > I feel like most of what I read about payment for order flow is insane? Otherwise normal people will start out mainstream explainer articles by saying, like, “Robinhood sells your order to Citadel so Citadel can front-run it.” No! First of all, it is illegal to front-run your order, and the Securities and Exchange Commission does, you know, keep an eye on this stuff. Second, the wholesaler is ordinarily filling your order at a price that is better than what’s available in the public market, so “front-running”—going out and buying on the stock exchange and then turning around and selling to you at a profit—doesn’t work. Third, because retail orders are generally uninformative, the wholesaler is not rubbing its hands together being like “bwahahaha now I know that Matt Levine is buying GameStop, it will definitely go up, I must buy a ton of it before he gets any!” The whole story is widely accepted but also completely transparent nonsense.

1oooqooq 2y ago
it's already public that frontrunning is perfectly legal if you can do it with large volume as to not show intent of frontrunning one single person.
- slt2021 2y ago
  yeah, Citadel's annual $30,000,000,000 profit is not coming out of thin air or just from bid-ask spread. Customers are being taken for a ride definitely
deleted 2y ago
[deleted]

taway789aaa6 2y ago

> PFOF and excessive off-exchange trading persist because so many trading platforms rely on the revenue it generates, essentially productizing their clients. Defenders of PFOF have claimed that retail brokers who route to high-speed traders (in exchange for PFOF) provide better price execution for investors and that it’s a net positive, despite creating an inherent misalignment between these platforms and their customers, and despite public evidence to the contrary. Leaning on the flawed argument that they categorically provide retail customers with best price execution quality, there is little by way of self-regulation to foment change or prevent applications designed to optimize transaction volume (i.e. speculation and day trading) and risky activity (i.e. margin and options trading). Further, their ability to claim best execution is part of the flaw of the system, as even within the current structure better outcomes are possible on an order-by-order, and aggregated basis. https://advocacy.urvin.finance/advocacy/we-the-investors-pfof-sign-on https://advocacy.urvin.finance/advocacy/we-the-investors-pfo... Not a win win.

gruez 2y ago
>and despite public evidence to the contrary Sounds serious, I wonder what it is... >"410 The author deleted this Medium story". doesn't look promising. The rest of the paragraph fails to state any concrete harm, instead focusing on abstract issues like "misalignment between these platforms and their customers", and "little by way of self-regulation ".
highwaylights 2y ago
This. It seems very much like that bogus stat that HR departments were peddling 20 years ago about how they only hire the top X% of people because they reject (100-X)% applicants - it tells you nothing about the quality in the gap. These systems don't have to actively attempt to front-run you or pro-actively make bad trades, they can just optimize for deal flow, which is enough to cause the customer to get a sub-optimal price.
- freeone3000 2y ago
  You’re getting a price as good or better than if you had routed it through the backing exchange directly. National Bid or Best Offer continues to be the rule.

throwacomment 2y ago

Yes, PFOF is woefully misunderstood but its very much not win win win. The reason its bad is because its anti-competive and gives them information that no-one else has access to. By trading against you, Citadel prevents any other potential market maker from trading with you. With less competition, the spread widens and even after price improvement, you're paying more. PFOF also tells them who they are trading against but anyone else who just sees a quote doesn't know that. Generally, things are very zero sum so wins all around are very unlikely. But some thinking is needed to track where the value loss and gains are.

wrsh07 2y ago
Please see my other comment that provides links to a study that shows: yes you get the best price from a broker using pfof Your argument seems reasonable but isn't borne out empirically https://news.ycombinator.com/item?id=42378516 https://news.ycombinator.com/item?id=42378516
- throwacomment 2y ago
  I'm not talking about you getting a worse price today. Suppose in some other industry, some monopolist consistently sells goods at a loss to drive out all the competition. In the last moments when they are doing this, yes its cheaper for you to buy from the monopolist at that moment. But after everyone is driven out of the market, you'll be paying more. Even though the monopolist is still the cheapest amongst all options. I'm saying you're already in the "after" scenario here. You're saying that you can save a few cents with PFOF when you cross that 50 cents spread and yes that's true. But I'm saying that spread should be 25 cents and no-one is offering that because they've been driven out. Now that I think about it, the more immediate consequence to you is that some of your order will not fill because PFOF exists, rather than you getting a worst price. Say you put a bid to buy at 100. And then I come along and want to sell at 100. Normally, you'd get to buy from me. But because my order is PFOF'd, Citadel decides that buying from me at 101 is a good deal so they do. This happens a few time with different sellers then you get fed up and/or the market moves. So you raise your bid to 150. Citadel sells to you at 149. You saved 1 off that 150 but lost out 49 from the trade you'd have gotten from me without PFOF.

lldb 2y ago

It is not a win. In a recent study, Robinhood with Citadel has the worst price improvement (execution quality) of any brokerage on the market. I’ve personally observed this - Robinhood might “improve” by 1/10 of a cent from NBBO while Fidelity is frequently closer to the mid.

loeg 2y ago
How is that not a win? Robinhood customers still got better execution than NBBO. If you don't like Robinhood getting a tiny kickback here, you're free to go to another brokerage.
wrsh07 2y ago
This is just noting that different brokers give different performance That doesn't really have anything to do with pfof (TD Ameritrade gives better execution and receives pfof) https://news.ycombinator.com/item?id=42378516 https://news.ycombinator.com/item?id=42378516
- loeg 2y ago
  Presumably a market maker would pay (PFOF) slightly more to deliver slightly worse execution (keeping the spread).
  - wrsh07 2y ago
    Sure that sounds plausible but it's literally not what happens in practice (see the other comment I linked that discusses research on this very thing)
    - loeg 2y ago
      Yeah, I've seen the Levine column on it.

neximo64 2y ago

Distorted incentives

WiSaGaN 2y ago

It's not. Centralization of liquidity is better for everyone. HFT thrives on fragmentation of liquidity. HFT is not wrong, but fragmentation of liquidity is.

rjrdi38dbbdb 2y ago
Nope. It's not better for known uninformed traders. If you mix them in with informed traders, market makers must widen spreads. This is very obvious in institutional FX. Pure "retail" flow will get quoted much tighter spreads by banks and market makwrs than you'll see on any ECN. Yes, it can get skweded against predictable flow, but a true "noise" trader won't be affected by that and will definitely be better off with tailored liquidity.
- WiSaGaN 2y ago
  You don’t have to trade with market makers.
  - rjrdi38dbbdb 2y ago
    So you're hoping get price improvement by crossing with other trader orders in the book? Unless you have a good high frequency predictor and low latency order management (you don't), you're going to experience adverse selection. Either because you're taking resting orders that HFTs are smart enough to avoid or because your resting orders get run over by informed traders.
    - WiSaGaN 2y ago
      So you are saying HFT will avoid your market order in this case, while HFT will provide better price when they are the sole counter party in separate liquidity pool? HFT will always maximize profit. To have multiple venues you are just paying HFT as middle man to transfer liquidity from one to another, where you can trade directly with each other if everyone is on one venue, e.g. one centralized limit order book. Transfering liquidity is not HFT's fault, but saying paying for order flow is better for retail is just disinformation. Without evenly discussing the function of HFT, you will get disinformation that demonize HFT as well, and common people won't listen to you later.

nobodywillobsrv 2y ago

Adverse selection goes both ways. If PFOF leads to adverse selection against your flow then it's not win-win. You might say you are willing to trade of adverse selection up to the cost of the fees, but then you are trading a known fixed fee for an unknown stochastic penalty. And also who sets the fees? The entire thing is adversarial and it's really just a choice of game you choose to play.