Comment by CSSer | Hacker News Reader

Comment by CSSer | Hacker News Reader

The first thing I did was open the article and search for PFOF (Payment for Order Flow).

> This proposal would address a controversial practice called payment for order flow, in which some brokers collect rebates for sending customers’ orders to wholesalers. Mr. Gensler has called the practice a conflict of interest and, in past statements, left open the possibility of banning it. The SEC’s best-execution proposal doesn’t go that far. But it imposes additional obligations on brokers that engage in payment for order flow to help ensure that customers are getting a good deal.

Shame. They’re skimming money straight off the top. Perhaps I should withhold judgment but I suspect they’re banking on the idea that Joe Schmoe, who downloaded an app to gamble with his future, isn’t going to seek out this financial disclosure data. I have a friend who can rattle off everything there is to know about option spreads and general technical analysis drivel. He initially didn’t believe me when I told him about PFOF.

PFOF is not a problem, except that it hurts your pension funds. PFOF needs to be price improvement. Research has been done and it _does_ give price improvement.

The main point of PFOF is that high frequency traders have much less risk when trading with single persons than they do trading with big players. They are willing to offer them much better prices than they will offer big players. Suppose there is 10cents difference. PFOF means they pay your broker, say 5c to give you a 5c better price. You are better off, your broker is better off, the high frequency traders are better off. The only people worse off are the big players. Because when HFTs can filter out the low risk trades, the high risk trades get more expensive for them.

Research has been done showing that different brokers split the price advantage differently. Robin hood, IIRC was one the worse side, allocating 80% of price advantage to PFOF, leaving only 20% to the customer. But the customer is still better off than paying the public exchange rate.

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The above was written before I found this report: https://www.afm.nl/~/profmedia/files/nieuws/2022/afm-paper-a...

I found it trying to find the source for the research I quote. That stat came from Matt Levine's newsletter. This report contradicts what I wrote above. It does seem that the report is about european brokers, whilst Matt Levine was talking about US brokers.

edit: I believe this is the orginal source regarding US markets: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4189239

>Research has been done showing that different brokers split the price advantage differently. Robin hood, IIRC was one the worse side, allocating 80% of price advantage to PFOF, leaving only 20% to the customer. But the customer is still better off than paying the public exchange rate.

But why should Robinhood or whoever else get part of the 10 cents that the algo is offering me, the little ol' retail investor? Just because they're in position to gobble some of it up without me knowing?

Because they’re offering you “free” trades and making their money from their cut of that price advantage rather than charging you $5?

I don’t use Robinhood, but I don’t see anything wrong with that pricing model. Prohibiting it would be equivalent to banning no-fee trades for small time retail investors. It would be like banning ad-supported business models. Well, on second thought…

Because they built the app you are trading on, made the agreements with the HFT, and are facilitating the trade?

I mean because you’re using their platform and these are the terms - people have always been free to use other brokers, like the ones that charged commission.

Regulations also mean that you have to get NBBO or better so your fill price is never worse than the market

When its used in dark pools and used the internalize orders. I mean, how can a stock have repeat 90% buy to sell ratio for over 2 years and still go down? Makes no sense.

There is no such thing as a "90% buy to sell ratio", because every transaction consists of a buy and an equal-sized sell. You can try to classify each marketable transaction in terms of whether buyers or sellers were more aggressive, but that doesn't tell you anything about the state of the order book and the amount of resting orders that are present. Large portfolio do not unwind their positions by just throwing everything into the market as marketable orders, they put chunk after chunk of it into the order book as resting orders. That can easily drive down the price even if it looks like buyers are more aggressive in terms of marketable orders.

Who's skimming off money where now?

Institutional investors. I can’t explain it better than Matt Levine’s article. It’s well worth the read, and it links directly to the SEC proposal if you’d like to read deeper from there.

After reading the article, my take is less harsh. It is really bizarre to me why instead of outright banning it, they just want to make it a really bad deal to do so. But if it works, great! We’ll see.

Levine doesn't believe PFOF involves people skimming money from retail investors, if that's what you're implying. Levine's story boils down to: retail order flow is cheaper to make markets for, wholesalers and brokers can split the savings three ways (between retail investors, the broker [via PFOF], and the wholesaler). That's not skimming; that's, like, the operating principle of Walmart.

There's an argument that it artificially increases spreads in lit markets, since you have segregated the least toxic flow to only go to a few select players (largely Citadel and Virtu). Further, these increased spreads mean that the 'price improvement' is only price-improved against a spread that's being quoted against only the most toxic flow. However, many spreads are still close to a single tick, although this is less true as individual ticker prices have generally gotten higher.

The tick size changes are interesting as well in the context of auctions. If a claim is "you can't have an auction with sub-penny pricing so there's no improvement", well then make the tick size smaller.

Another argument against PFOF is that brokers could (and Robinhood has been caught doing it) be incentivized to route orders to the highest PFOF rather than executing at the best real price.

As a retail investor, I’d rather have PFOF and free trading instead of paying $5 to $10 a trade which is more expensive than spread improvements.

That’s what PFOF has brought to retail investors. It’s not like retail investors was ever put onto the public exchanges prior to robinhood and PFOF, they were sent to dark pools for institutional investors to trade against but retail investor never got the benefit.

PFOF isn't gigantic revenue driver for many retail brokerages, including some that offer zero commission trading (like Schwab). Robinhood may have started the price war while making most of its money from PFOF, but you can have low to zero commission trading without PFOF.

The payments per share tend to be extremely small - on most symbols the broker isn't making $5-10 per trade from the MM, for reasonably sized trades.

Even if payment for flow was costing you that much, paying for an order vs giving more price improvement are indistinguishable. Payment for order flow just means that price improvement definitely goes to the broker instead of back to you.

Robinhood forced the discount brokers to adopt zero commissions. Robinhood only exists because of PFOF. Being on Schwab you indirectly benefited from PFOF and Robinhood because you don’t pay commissions. I personally don’t use Robinhood but I recognize that they have been beneficial to me.

Matt Levine:

> The customers think they have no cause for complaint, because they did better than the NBBO. The whole thing is an institutional equivalent of retail payment for order flow: The partner firms fill the customers at a better price than the NBBO, make some profit for themselves, and kick back some of it to the broker (Coda).

https://www.bloomberg.com/news/newsletters/2021-09-23/money-...

Where is the money skimmed from the retail investor there? They beat the NBBO?

Levine is entitled to his opinion, but I don't think he has argued that retail investors receive better prices compared to a condition where all of their orders are sent to lit venues and makers who want retail flow have to get it by having top-of-book (or midpoint peg or whatever) orders at lit venues.

It's not so much his opinion as the law. Wholesalers have to improve the lit market price, or else route the order to the lit market. And it's clear how they're able to improve that price! The lit market has to serve institutional traders, who are much more expensive to trade against.

The law obviously does not say anything about price improvement compared to counterfactuals either.

Are you saying that if makers' profitability at lit venues was greatly improved, they wouldn't compete to offer tighter spreads at all?

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