Isn't this the entire idea behind Robinhood? Obviously, they make money elsewhere (from interests on deposits?) but hasn't it been clear for years that they were getting paid by internalizers for order flow?
Whoever you use to place stock market orders is also getting paid the same way. People have a funny idea of what a retail brokerage does. They do not execute orders on exchanges for you; that's a specialized capability that long ago became its own kind of company. Retail brokerages specialize in picking up the phone when you call with a complaint or request, and in advertising to acquire users.
You shouldn't care. The reason your order flow is valuable isn't that Citadel is trying to screw you. Rather, they can (occasionally) quote you better prices than they do the market as a whole, because they know you're not a giant investment bank or hedge fund about to roll over them like a freight train with a giant block order that will demolish every level of the order book. Internalizers can essentially arbitrage the difference. They're required by law to meet or improve the NBBO.
I think they might literally be the only one? Here's a quote I found (this time on Marginal Revolution):
It should be shocking, but it probably is not, that according to the Rule 606 reports mandated by the U.S. Securities and Exchange Commission, no major online broker, with the sole exception of Interactive Brokers, sent more than 5% of its orders to an organized exchange. More than 95% of their orders go to internalizers!
Later: Like, a minute later I read their Rule 606 report, and they do in fact get rebated for sending order flow to dark pools. They also get paid to take institutional orders and trade them against their customers.
Yea....Timber Hill is owned by Thomas Petterffy, founder of Interactive Brokers, and handles much of the options order flow from IB users. So...IB may not be making money off those trades, but the founder is still profiting from them. Don't get me wrong, as someone who has followed market structure for years, I don't think that IB is doing anything worse than anyone else, but they aren't innocent in this regard.
Timber Hill did not participate in the retail business to avoid conflict of interests with IB.
For what it's worth, one can't internalize options orders in the same way one can equity orders, purchased options flow must make it to the market. I'm not familiar with the history of this decision but I suspect it's since options are less liquid and have higher spreads, so internalization would get a much worse deal than say auctions. You can rebates from certain exchanges for initiating auctions on them, and can selectively initiate auctions on exchanges which benefit you more, but options orders themselves make it to the market
Quite regularly, I see that my orders are filled at Timber Hill, when there are other participants offering at the same price. We may be quibbling over the definition of "internalization", but that is internalization.
It is strictly not internalization, in fact, and as far as I know from friends working on retail at the new owner of Timber Hill IB and Timber Hill didn't ever cooperate on optimal routing strategies since Thomas Pterfry didn't want people loosing faith in IB routing. There are plenty of reasons why Timber Hill might win the trade:
* They might be first in the queue on a price-time exchange, and so naturally get the order
* They might be on a price-size exchange, and so get some of the fill simply by being present.
* They probably participate in the auction process, and will naturally get some portion of orders that IB initiates
For what it's worth, Timber Hill USA was bought by Two Sigma ~1 year ago. It wasn't actually unprofitable as shown by public filings, but wasn't making much and Thomas Pterfry didn't want an illusion of conflict of interest.
What you say about them "winning" the trade is not accurate. If it were happening on an exchange, as in each of your three examples, the trade would show as being on that exchange, and I wouldn't know who the counterparty was. If the exchange is "Timber Hill", then IB chose to route the order there, which is internalization.
If you're talking about the USA, this is incorrect. I actually work in the industry and know how this works
* One has to initiate an auction of the client order, at least in the USA - see https://www.sec.gov/rules/concept/34-49175.htm#P193_52817, specifically "Unlike internalization in the over-the-counter equity market, the options exchanges' rules permit a firm to trade with its own customer's order only after an auction in which other members of that market have an opportunity to participate in the trade at the proposed price or an improved price. This auction provides some assurance that the customer's order is executed at the best price any member in that market is willing to offer". In practice the placing firm will bid for the auction at that price, and non-competitive prices don't get posted since then the firm has to lose money.
* counterparty data is reported by the OCC so regardless of where the order was executed you will know who was the counterparty. It's fairly easy for IB to know whether Timber Hill executed an order, whether or not they intentionally routed it there.
Second, I actually have inside knowledge of a sort about how Timber Hill USA worked before getting purchased by Two Sigma, and they did not work with IB to take customer orders and weren't to happy when they did get customer orders that originated from IB, specifically because people then run around complaining that IB is up to spooky business internalizing with Timber Hill.
this article is extremely misleading, creating what essentially is a fake controversy. I highly recommend reading this SEC guide to understand how it really works.
This is called pfof. Pay for order flow. It's very common practice to sell retail flow or exhaust flow to the likes of citadel and a dozen others.
The buyers make money by either taking the spread on an order, reducing risk in their own portfolio or using the order to create impact and internalizing the tail.
According to this analysis https://seekingalpha.com/article/4205379-robinhood-making-mi... HFTs pay Robinhood significantly more for their order flow than other brokerage firms i.e. claiming almost 12x more than E-Trade makes ($260 per $1m in orders vs $22 per $1m). If this is true (I haven't independently verified but these fees must be published publicly by law), then clearly HFTs are getting something more from RH than they are from other brokerages.
The author goes on to say "Robinhood is well on their way to making hundreds of millions of dollars in cash income by selling their customers' orders to the HFT meat grinder. High-frequency traders are not charities. The only reason high-frequency traders would pay Robinhood tens to hundreds of millions of dollars is that they can exploit the retail customers for far more than they pay Robinhood."
I read that analysis when it came out. I'm not sure how accurate it is... in the end Robinhood still needs to make money since they aren't charging the typical per trade commissions.
You can probably back out what the HFTs margin is on this stuff by looking at public financials... KCG was public for a while.
Because individual retail traders are (a) generally uninformed and (b) relative to institutions, have very small positions they want to move in the market. Those orders are intrinsically more valuable, because they aren't risky to make markets for.
Essentially, your trades have a lower cost basis than those of institutions. But the markets are generally priced assuming institutional traders. So if firms know you're not an exchange they can save some money on you, and Robinhood literally passes some of those savings to you.
(I don't love Robinhood or anything, but the model makes perfect sense.)
It might simply just be that's the terms that Robinhood reached with the firms? Paying 0.2c/share and giving 0.2c/share price improvement is fairly similar from the perspective of a market maker as just paying 0.4c/share, and Robinhood might be funding themselves by having firms only compete on payment for orders and not on price improvement.
On a more meta level, my firm suspects that Citadel is trying very hard to price other players out of the market even if it's at the cost of their current profitability, so they might be driving up the terms of newly minted deals. I don't work on the retail desk so I don't know.
As someone that paid $25,000 in options commissions in 2015 even after negotiating down to 50 cents/contract and no ticket charge, free options trading in exchange for my trade data is a fair trade
Now if only they'd give the option of Portfolio Margining instead of just Reg-T margining, I'd let the HFT's pair-program with me in person.
Exactly how do you think you're paying it here? Be specific.
Later: to be clear, my subtext is that Robinhood customers aren't actually paying anything and are sort of getting a free lunch here. The money Robinhood pockets from your trades isn't available to you in any form, at least until someone starts the brokerage that pays you to trade.
1. RH user wants to buy 1000 shares of XYZ. Offer price is $10.00
2. RH forwards the full order to their execution venue partner. They get paid (assuming SeekingAlpha story is true) $260/$1mm traded, or $2.60.
3. Executor takes the order and immediately sends 900 shares to the market, lifting the offers. Now best offer is $10.10
4. Executor facilitates the tail of the order, 100 shares, at $10.10. So they are short -100 shares here - or they can give a de minimis price improvement (like 10.0985) to meet their contractual obligations.
5. Temporary market impact attenuates and offer mean reverts to $10.05
6. Executor still has risk on their books - but their paper mark-to-market profit is $5.00.
7. Risk can be mitigated by waiting for crossing order or waiting for more favorable offers to close out the short.
So roughly speaking they paid $2.60 to get the order, but made $5 on it...
I'm having a hard time believing this is actually a common case. The flow you've laid out almost certainly breaks SEC rules - Credit Suisse's (now closed) retail execution unit was fined for this exact trade less than a month ago (https://www.sec.gov/news/press-release/2018-224). If this is how internalizers make money, they should all be in existential crisis right now. As far as I can tell, they are not.
The SEC cracks down hard on ATSs. But it's rarely for what they do. It's for what they didn't do ... Which is be transparent and disclose. This is the case in the link and something I've observed with all these SEC actions brought against ATSs.
The flow I explained in one way these guys make money. It's certainly exaggerated. At the one place I worked we ran a $0.5bn book of this stuff. You don't always get chances to get out. So risk management is key. Your book turns over every few days.
Sure, most SEC complaints are for lack of transparency, because they don't have laws against a lot of the stuff they want to stop. But they don't go around prosecuting for lack of transparency of good things. If they fined someone for it, it's probably because they don't approve of the thing they did, which is a good sign they're going to fine others that do it.
And it's not like a lot of internalizers are going around with prospectuses saying "we're gonna purposefully move markets to give your customers worse prices", so the SEC isn't going to have much trouble fining them if they decide to (assuming this is actually happening all the time).
That's how you're saying the internalizer made money on it. Obviously, they make money on the order flow. The question is how they cost you anything. What could you have done differently to capture the $2.40 in hypothetical profits here?
So, first off, I am not saying internalizers are all evil and that pfof is bad. That $2.40 your retail trade earned the internalizer is the price you pay for convenience and immediacy. You let someone else handle the order and they do what they want with it - within certain guidelines.
You could have saved the hypothetical $2.40 had you traded differently, albeit slower, and caused less market impact with your order. Of course, trading slower comes with its own slippage risk or opportunity cost that the market moves out of your favor. But it could also move in your favor... However, if you let a greedy HFT use your order to impact the market - it will always be out of your favor.
For a small retail guy, you are powerless unless there is a RobinHood 2.0 that decides to offer comm-free trades + does not sell your orders + makes money doing something else ... stock loan maybe?
EDIT: Also the HFTs hate limit orders because it reduces the amount they can internalize. They also generally have a contractual obligation to always execute your order. So you can always use a limit at or inside the offer if youre buying, and potentially save on that cost.
I don't understand the outline of your argument. If what you're saying is true, then you can non-hypothetically save that $2.40 by... trading slower and with less impact on the market.
This is why I asked for specificity. Yes, we agree, internalizers pay for order flow because they can make money on it. The question is: can you make that money on your own order flow, or is the allocation of orders to internalizers Pareto-optimal?
Internalizers want the entire order. If RH splits a order across multiple internalizers they will not be happy. So RH allocates in a Pareto-optimal way. As the order creator, you cannot earn that $2.40, you can only save by getting a better price.
Upthread, you said "It's never free. You're always paying somewhere." But it turns out to be pretty hard to even describe how Robinhood customers are "paying" for their order routing.
IEX's speed bump in the end simply allowed their special internal dpeg order type to pull slightly back when they saw adverse movements incoming, for many normal trades it's essentially an exchange that acts like it's a little farther away (longer latency) than it actually is with some dark order types which move weird.
This trade is theoretically possible, but customers don't frequently trade enough volume to move all the lit markets that much, and it's extremely dubious from a legal perspective anyways.
Yeah I don't really care about the semantics here, it is commissionless. My strategies aren't materially affected by some broker-level BS, I am satisfied with the fills I get on Robinhood vs what I can see on the order books using other tools.
At the beginning of the article, the authors cite 3 anonymous sources:
> ... according to three people with knowledge of the matter, who asked not to be identified because the details are private...
Then, the end of the article mentions 3 VCs:
> Two venture capitalists, speaking on condition of anonymity because the discussions were private, expressed concern that Robinhood's ties to high-frequency traders might undermine its image and stymie expansion plans. A third said it was the reason he didn't invest.
I wonder if this article is the product of some VC sour grapes.
I was under the impression that retail order flow is mostly useless to HFT and they make money on large institutional moves - retail investors just don't affect the market enough for it to matter.
Is that a wrong assumption? If not, seems like maybe RH is just taking advantage of the rebate for not much benefit to Citadel?
> retail order flow is mostly useless to HFT and they make money on large institutional moves
This is incorrect. Retail volumes are smaller. (This also makes them less risky to fill and offload.) But spreads are wider.
I worked on an algorithmic derivatives desk many years ago. We paid a well-known national broker lots of money to get their options flow. Their customers were notorious for forgetting to exercise slightly in-the-money options, putting in misplaced limit orders, putting in market orders for illiquid names, et cetera.
Robinhood has its hands on the money of a generation that was too young to lose money in the last crisis.
It's the other way around. Retail flow is uninformed. Many crossing opportunities as well. It's extremely valuable to hft folks.
On the other hand if you're trading against a hedge fund... You don't know what info they have. You also don't know when they'll stop buying or selling. Their orders could come across multiple days. You don't want to touch that stuff
Hmm, I'm assuming this is illegal (otherwise someone would likely be doing it) but why doesn't a high frequency trading firm make a competing application and just keep that order flow for themselves? Why not vertically integrate?
ETrade actually had an in-house proprietary trading unit that was making so much money that they sold it off because the regulators were asking questions.
Seriously you'd think on a board ostensibly obsessed with CAC and ARPU metrics, it would be immediately obvious why a specialty player wouldn't want to compete with Schwab and Fidelity.
Multiple players along the chain could decide to vertically integrate. Although I used the example of high frequency traders, a better question which I should have asked is why hasn't someone dipped their toes into retail and HFT? It seems like someone would want to grab that land for themselves if it were particularly valuable, which the valuation of Robinhood purports. Considering some guys in that industry made this app, I don't think it's too far a stretch of the imagination for someone to believe that an industry player could have made that move.
If you're an HFT, you would much rather just pay for the order flow and not deal with all the shit that is retail (government, customers, all that shit). If you're some big retail firm, you're probably run by suits, way to beauracratic to run a difficult high-tech trading team, and any talent you got would get siphoned off to a good trading firm.
Does Freetrade say somewhere that they don't pay for execution services from some other company? If they don't, is that a good thing? Doesn't that imply that they think they can outcompete Citadel and Two Sigma on execution? Because, like, they can't? Right?
> A year in the making, Freetrade has built a bona-fide “challenger broker,” including obtaining the required license from the FCA (the U.K. regulator), rather than simply partnering with an established broker as it is understood Revolut initially plans to do. This, Dodds explained on a call, has enabled the startup to plug directly into the capital markets “piping,” with as few intermediaries as possible. It means Freetrade can execute trades on its own behalf and ultimately be much more in control of its own destiny. It should also help the startup maintain a lower cost-base as the app scales.
I saw that, but that just says they have (in some circumstances) the option to place their orders. I'm unclear why that would necessarily be a good thing, but either way: have they made a clear statement that they're not farming retail orders out to other firms? If they are, they're going to get paid for them.
Their entire business model seems to be extremely transparent[1], and they treat their users as customers, not products. I don't know what they are doing now, but I think that farming retail orders out is not something they would be focused on in the long run. It's more like "mobile-first Interactive Brokers for equity trading".
> Their 'default' order price is a market order that they promise will not clear until after hours or the next day.
Isn't this only true for the non-paying users, who are not subscribers of their premium plan? That's probably their entire (freemium) business model. It's the same with Revolut: free users might lose more money in foreign exchange and withdrawal fees, which pushes them to upgrade[1].
Even if you pay them $10/mo (whether you trade or don't, and keeping in mind that most people shouldn't be trading most months!), they still charge you for "instant" orders (the kind they don't delay purposely) in the one market they actually execute orders in.
That's a good point. It's hard to compare a crowdfunded company with a one burning through more than 500 mln USD in VC funding. But I see no reason why people shouldn't be increasing their passive portfolios every month if they can. And with many brokers, $10 is around a minimum commission for a single trade.
In the US they would be required to disclose how much they are being compensated for that. I don't know if that is a requirement for the UK so have been unable to magic search term my way to their disclosures.
Because I am curious about such things and had a moment I went and looked it up. In the UK payment for order flow is effectively banned (there are some firms who are trying to say they aren't brokers so it isn't payment for order flow but the FCA has taken a dim view of this practice).
This is true, but it uses an unfortunate industry term that is more pejorative sounding than it actually is.
When people in the industry talk about 'dumb money' they aren't talking about how informed or intelligent the order flow is. They are talking about how likely the order relates to market structure.
An individual investor who has looked at their portfolio and decided that the best move for their investment horizon is to move a big component out of equities and into bonds is still 'dumb money'. Even though that might be the most intelligent option.
A bot that has a terribly performing algorithm that takes market structure into account is not dumb money though.
When people talk about 'the stock market' or 'the stock price' they are using a very coarse abstraction.
In reality for most trade-able instruments there are a variety of exchanges all operating at once. Further in each exchange there isn't a single price. There is a collection of buy and sell orders that combined together form the 'book'. For instance if you had 10 buy orders at $1 and 2000 sell orders at $1.10 what is the 'price' of that thing? The structure of the book and how all the exchanges relate (and Reg NMS in the US equities space) are all the 'market structure'.
In this specific case, it means that retail flow is much less likely to immediately move the market than flow from an informed (knows the market will move soon) or large (will trade so much that it will move the market) player, and is much more valuable to market makers who try to capture the spread on that order (and usually improve it) and hedge/trade out of that risk relatively soon.
I don't have any inside information about Robinhood's infrastructure, but I'd be willing to bet the mobile phone thing is a red herring.
HFT will take that bet on the other side of every retail investor they can get their hands on, including those with very sophisticated trading terminals. For that matter they will take the other side for very sophisticated non-retail investors so long as its non-directional flow.
Robinhood locked me out of my own account because I was "traveling too long"; demanded I show them proof of US residence (my verified Chase Bank account and US passport aren't good enough). I'm not surprised they're hurting the little guy.
ProTip: use LIMIT/STOP orders when buying and selling. Sending MARKET orders to Robinhood guarantees you going to get a "worse" price compared to the spot price.
Does this apply to an ordinary low-level retirement investor like me? If I am buying, let's say $500 a week, in some fund as part of my IRA, what does a LIMIT/STOP order do for me? I'm buying it no matter what, the share price is meaningless to me, I will just get more or less shares.
I don’t even know that you can put a limit order on mutual fund purchases. My gut tends to doubt it, but I’m too lazy to go try.
Regardless, I’ve traded for decades and on high-volume stocks (which are the ones you’re likely to trade), putting limit orders in is a waste of effort. For some folks, it’s important to save a few cents. For you, not so much. Different story on penny stock or < 100K/day in volume, but if you’re buying AAPL just put a market order in.
For example buying a LIMIT says the highest price I am willing to pay per share is X. So you can be confident you'll get a price at least equal to or below the limit price.
> the share price is meaningless to me
??? Confused. Do you like buying high and selling low?
There is also the case when no one else wants to sell (buy) and bids (asks) way out number asks (bids), especially on contracts that people are using to cover for their other trades. There's plenty of times where I massaged the price up (or down) to where I wanted it more, and dumped/slurped up contracts (at least confirming by checking the bar once it filled and seeing that the price I got filled at was the highest/lowest price of that bar). Granted, it doesn't happen every time, nor do I count on it.
I'm not sure I completely understand this article, but I'd like to take this opportunity to rant about my recent experience using Robinhood. Two weeks ago I noticed that Tesla stock dropped significantly after the SEC's investigation into Elon Musk's "funding secured" tweet led to Elon being ousted as chairman of the board. I thought the stock would recover from this, so I placed a market price order for TSLA shares on Sunday night (September 30th). Indeed, on Monday the stock rose +17% but lo and behold, my order never went through. The reason given was that the stock price had supposedly changed by at least 5% by the time the market opened. I suspect this is because Robinhood prioritizes orders from high speed trading firms over its own customers. Is this common practice, and can anyone recommend a service that doesn't do this? Thanks in advance.
You sent a market order while the market was actually closed, so it could not be executed at the time. RH was protecting you from getting a fill far away from the last price, because the stock gapped up massively that Monday. 264.77 was the close on Friday, and 305.77 was the open on Monday. You should be thanking them, because otherwise your position would be around $45 under water by now. Never use market orders outside of regular trading hours; you have no idea where you are going to get filled.
It was obvious to many people that the stock price would rebound significantly after Musk settled with the SEC, so the stock had already effectively increased in price before market open. Robinhood couldn't find anyone willing to sell you shares at the market close price Monday morning because there were none to be had.
The settlement news came out earlier - Friday’s news was Musk’s punishment, which was light. But thanks for the reminder that stock prices are not numbers on an app, in my rage/greed I forgot how markets operate.
I think Robinhood implements market orders as limit %5 above/below market. You should be able to enter a limit order at your own max price, and it would've executed.
I think this is because when you do a “market order” on Robinhood it’s actually placed as a limit order 5% above the price. Just set your own limit order next time
i'll take the "never use market orders outside of market hours" and extend it to "never use market orders". specify what you're willing to pay. it should also lessen any anxiety about people paying for your order flow, as they can't make you pay more than you already decided you were happy to pay for the equity.
https://news.ycombinator.com/item?id=17998846