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http://Public.com just announced they're turning off Payment For Order Flow, which will shine the light on Robinhood's PFOF practice
The idea is simple: market makers pay Robinhood for the privilege of handling your order
Does that mean you're getting ripped off?
The idea is simple: market makers pay Robinhood for the privilege of handling your order
Does that mean you're getting ripped off?
What actually happens when you place an order in the RH app?
Generally, a retail brokerage will send all orders through a smart order router
That router connects to many destinations (Market makers, ATSs and exchanges)
Generally, a retail brokerage will send all orders through a smart order router
That router connects to many destinations (Market makers, ATSs and exchanges)
The router is getting quotes in realtime from each destination to make an instant decision where to send the order
In that decision, Robinhood has to comply with the NBBO rules of Reg NMS: they must execute the order at the lowest ask or highest bid available from the exchanges
In that decision, Robinhood has to comply with the NBBO rules of Reg NMS: they must execute the order at the lowest ask or highest bid available from the exchanges
I don't work at Robinhood, but I'd bet that they're also receiving a realtime feed from each Market Maker for what price they're willing to handle an order in a particular security at that time.
They'd use this, plus the quotes from each destination, to route the order.
They'd use this, plus the quotes from each destination, to route the order.
Some % of orders go directly to exchanges, while many go to the MMs like Citadel Securities.
Once the MM receives the orders, it decides whether to execute it directly (so Citadel sells to the RH buyer) or to forward the order to another venue, like the exchange.
Once the MM receives the orders, it decides whether to execute it directly (so Citadel sells to the RH buyer) or to forward the order to another venue, like the exchange.
A common misconception I see is that RH "bundles" up customer data and sells it to hedge funds. That's not really true - the actual orders, in realtime, are the data.
To recap, market makers pay Robinhood so that they can handle your order.
So are you getting screwed?
To recap, market makers pay Robinhood so that they can handle your order.
So are you getting screwed?
The saying goes, "If the service is free, you're the product, not the customer"
Robinhood makes healthy revenue from margin & Gold accounts, but client order flow is their #1 product, and the customer is Market Makers
In the stock market, things are generally zero sum.
Robinhood makes healthy revenue from margin & Gold accounts, but client order flow is their #1 product, and the customer is Market Makers
In the stock market, things are generally zero sum.
But Market Makers are not buying customer order flow in order to screw the average joe on that individual trade.
They're buying order flow for the valuable real-time data that it represents in aggregate.
This data enables 2 things: Understanding Sentiment and Latency Arbitrage
They're buying order flow for the valuable real-time data that it represents in aggregate.
This data enables 2 things: Understanding Sentiment and Latency Arbitrage
The 1st is obvious. By being the middleman on a huge % of retail order flow, the MMs can derive the sentiment of the market in real time and broadly act on it
Sometimes, the other side of the MM's more informed trades are the retail customer, but more often they're other firms
Sometimes, the other side of the MM's more informed trades are the retail customer, but more often they're other firms
Latency Arbitrage is more interesting. Alongside retail orders, MMs execute large block trades on other venues like Dark Pools.
What if they, fractions of a second ahead of other participants, can detect where the market has moved and see another firm hasn't adjusted yet?
What if they, fractions of a second ahead of other participants, can detect where the market has moved and see another firm hasn't adjusted yet?
That means big $$ for them, at no cost to the retail investor.
The MM, because of PFOF data, can then buy wholesale inventory from dark pools to give retail order flow the NBBO price and still profit.
The MM, because of PFOF data, can then buy wholesale inventory from dark pools to give retail order flow the NBBO price and still profit.
So, does PFOF screw you?
Maybe? Not really? At least not as directly as you'd first assume when you hear "Hedge funds are paying for my data"
More often than not its a war between hedge funds that drives up the value of PFOF so that they can compete against one another
Maybe? Not really? At least not as directly as you'd first assume when you hear "Hedge funds are paying for my data"
More often than not its a war between hedge funds that drives up the value of PFOF so that they can compete against one another
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