Very Twattish Indeed

Like Facebook, Robinhood offers its core service free. Rather than charging trading fees, it relies on “payment for order flow” (PFOF), under which it hands the millions of trades made by its punters to hedge funds, which pay a small fee for the right to execute the trades. SEC chief Gary Gensler indicated last month that the stock market regulator could ban the practice because it raises “real issues around conflicts of interest” — between brokers such as Robinhood, market-makers that are typically hedge funds, such as Citadel Securities, and retail investors.

The likes of Citadel, run by Ken Griffin, the billionaire who last year spent $43 million on a copy of the American constitution, process more than 90 per cent of all retail trades in America. They make a small profit on the spread between the prices at which they buy and sell securities on behalf of Robinhood punters. Broadly, Robinhood charges more for volatile shares because the spread is wider, with greater potential for profits. More stable shares carry a smaller fee because the spread, and thus profit for market makers, is lower. The upshot, say critics, is that retail punters lose — they end up paying hundreds of millions more than they should.

The market maker’s spread will be higher on more volatile shares whether there is payment for order flow or not. So, the wider spreads are not a result of payment for order flow.

The basic contention is nonsense.

8 thoughts on “Very Twattish Indeed”

  1. Bloke in the Fourth Reich

    I have always wondered how these zero-fee platforms make money. The data alone, given that they have turned retail investment into a big thing with normal people now able to move markets (Gamestop) must be worth a fortune. I bet they do some front running on it.

    A lot of the punters are only there because they are supposedly “paying hundreds of millions more than they would” They aren’t, they are happy not to be paying commissions on every trade.

  2. Why is there a reliance on big market-makers in the first place? Betting markets allow you to act as a market-maker yourself; why don’t we have the same for stock markets?

  3. @Andrew M
    The market-makers are there to even out the gaps when no one wants to buy or no one wants to sell. Without the order flow they create there would be no way of correctly setting the price.

  4. @AndyF
    Which is, of course, why they make money from the spread. They carry the risk.

    It’s easier to understand this if you look back to how the LSE used to work with jobbers between broker & broker. You sold & bought from the jobber. So he had to have a position on his book. He had money in the game. Compensated by the spread. The spread contracted if it was easy for him to clear his position. Expanded as the price became more volatile or the stock was difficult to trade.
    Those days brokers were taking 1¼ commission. Now trading for the punter can be free. And the spreads don’t look much different. Remarkably good deal, I would have thought. Mouths of gift horses?

  5. “Betting markets allow you to act as a market-maker yourself; why don’t we have the same for stock markets?”

    Betting markets differ because they’re betting on individual events with with defined points at which the market is settled (the horses are weighed in; Her Maj invites the PM to form a government, etc.). At that point the punters’ net profits and losses are totalled up, and the betting exchange takes a commission from the net profits of the winners (e.g., 2% on Betfair).

    Financial markets don’t have those end points, so it’s hard to see where any exchange could otherwise take a commission payment, and hence pay for itself.

  6. @bloke in spain

    I recall one incident at a very major bank in London when the entire European desk trading team went on an unofficial skiing weekend in Switzerland hosted by the Zurich branch traders. There were travel issues getting back and no traders on the desk at market open which was a big issue where we were market makers. They got a support tech to set the spreads so high that no one would want to trade. It would have been very profitable but quite illegal to have accepted trades.

  7. The upshot, say critics, is that retail punters lose — they end up paying hundreds of millions more than they should.

    The other upshot, say critics, is that retail punters *exist* – they end up making hundreds of millions more than they should;)

    Gotta keep the proles in their place – can’t let the little people get enough mass to be able to threaten the establishment.

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