Yes, it's called "Payment for Order Flow". Very shady, I have a RobinHood Account, as do most kids my generation, but I really don't like what I saw in this CNBC Video How Does Robinhood Make Money. How is any of this even Legal? Why isn't the SEC investigating RobinHood? And how did these 20 something kids get away with this business model ? I know that they got viral growth by giving "free stock" worth between $2 and $200 for every account referral. That's why I'd signed up. I ended up getting a 2 $ penny stock They are valued at 5 BILLION!!!!
payment for order flow isn’t that shady. It keeps costs down - it’s the only way Robin Hood can give you free trades. That or they sell all your private information to Russian marketing firms. you get the hard benefit of lower commissions and give up the soft benefit of “better execution.”
Well, they disclose it on their 106 so it's public secret. To make this issue even more complex, every other retail broker sells your order flow too (if you use their default execution venue) and does not give you anything for free, so you get screwed on both ends. If your order is sold to any of the PFOF buyers (most probably Citadel in case of Robin Hood), it's not like you "lose money", you still get executed at NBBO or even better. What happens, however, is that HFTs treat your order as a source of optionality and you are more likely to get negatively selected within their timeframe. It's hard to say if it matters or not, commissions are hard dollars while negative selection on the scale of seconds is not.
Etrade, and ThinkorSwim are guilty of the same business practice. They sell your order flow to high frequency traders also.
It's true that it's hard to quantify. However in professional settings, Transaction Cost Analysis(TCA) is a big thing to help measure the effectiveness of the Smart Router. Most discount brokers will never provide this to their clients as it shines a light on the sub-par executions.
It's tricky even in a professional setting, even if you have some form of TCA. For example, if you are only measuring the actual cost of trading (something like EV at some time decaying horizon), you might be missing the opportunity cost and thus underestimating the negative selection. If you are measuring it with the missed opportunities, it's confusing because you need to make "ideal scenario" assumption or you end up measuring against aggressive execution. I am simply saying that from a retail investor perspective, commissions are hard dollars out of your pocket, while TC ex-fees is harder to quantify, especially if you trading on a much longer horizon.
True but what about measuring price improvement over NBBO? If what gives you significant improvement over a big sample than that would rank alot higher.
Yeah, you definitely lose money. It's just front running pure and simple. The SEC and FBI should get involved and shut these businesses down for good. You get executed at the NBBO, but is it at the NBBO at the millisecond the order was placed? No, they hold your order artificially for 1 - 30 seconds and execute your order at the NBBO of their choosing. Let's see: I place an order to buy 50k shares and then mysteriously and by a complete coincidence, the NBBO goes up by 10 ticks in 5 seconds. I get executed 5 seconds after placing the order at the NBBO. The only problem is that it's not the same NBBO that existed when I placed the order 5 seconds ago. Here's what happened: I got front run by 10 ticks while these fuckers were laughing their fucking asses off. Free money, with the SEC and FBI nowhere to be seen. Just imagine placing a CME futures order and getting an execution 5 seconds later. There is no technological reason why stock trades today or 20 years ago take an infinity to execute while futures don't. It's because you need time to front-run. You can't do much front-running if they delay the execution by 10 milliseconds, but you can definitely do a lot of front-running if you delay by 10 seconds. Imagine if you delayed/buffered order flow by 1 hour or 1 day and then you got to choose and pick any "NBBO" price from that time window as the execution price. I remember trading stocks in the late 90's in my Datek account. They were good because they only promised to front-run you by a maximum of 10 seconds ("Guaranteed execution in under 10 seconds") while for other brokers it was much longer than that. Except for NYSE stocks, that was like sending an order into a black hole and you had no idea if you would get a fill in 1 minute or 2 hours. That's because the specialist's job was to front run you. He took as long as he wanted, ignored cancel requests if he felt like it and halted the stock whenever he felt like it for however long he wanted and then reopened at a price of his choosing. The NYSE was just a front-running operation (is it still?).