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Toxicity is a well-defined technical term in market microstructure literature. It basically means whether the direction someone trades in predicts the short-term direction of the market.

It's not a moral judgement. So to answer your question, hedge fund order flow is considered highly toxic. Which is why Citadel Securities pays to interact with non-toxic retail flow, instead of toxic hedge fund flow.

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To understand toxic flow you have to know adverse selection. For example, you are asked to share a pizza with your brother. You are free to split it in half however you like, and your brother gets to pick which half to take. The most fair way is to split it in half otherwise he will select adversely. Market makers job is to quote the true price of an asset by offering to buy and sell at different prices without having one side picked off more than the other. So when adverse selection occurs too often over a period of time, they will simply throw in the towel and fold, regardless of whether their opponent is bluffing or not.

In this specific case, Robinhood often have worse price than NBBO, so they get to do liquidity arbitrage in addition to the less toxic retail orderflow.

Well, TIL... thanks.

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