Robinhood Is Making Millions Selling Out Their Millennial Customers To High-Frequency Traders

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Rowan Oak
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Robinhood Is Making Millions Selling Out Their Millennial Customers To High-Frequency Traders

Post by Rowan Oak » Tue Sep 11, 2018 1:07 pm

Most brokerages are doing a version of this (not Vanguard). Long term investors needn’t care. Short term traders are being misled by the word “free”.
(How does this cost the retail investor) In the prices your trades are executed at. It’s pennies. If you are investing, then it doesn’t matter.
-Josh Brown (The Reformed Broker)
Robinhood Is Making Millions Selling Out Their Millennial Customers To High-Frequency Traders (Seeking Alpha)
by Logan Kane
Robinhood isn't the worst thing to happen to online trading, but they market their service as a free/no-commission product, which has the effect of pushing trade volume through the roof. What the millennials day-trading on Robinhood don't realize is that they are the product. 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.
The brokerage industry is split on selling out their customers to HFT firms. Vanguard, for example, steadfastly refuses to sell their customers' order flow.
I advise my readers who are long-term investors to go with Vanguard
Last edited by Rowan Oak on Tue Sep 11, 2018 2:46 pm, edited 4 times in total.
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alpine_boglehead
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Re: Robinhood Is Making Millions Selling Out Their Millennial Customers To High-Frequency Traders

Post by alpine_boglehead » Tue Sep 11, 2018 1:50 pm

From the article:
The question you should be asking whenever someone in the financial industry offers you something for free is "What's the catch?" And yes, there is typically a catch.
For cross-reference, there's the voluminous Fidelity ZERO funds thread. Someone's paying the bill at the end of the day. As with the poker adage, if you don't know who the patsy is, it's probably you.
Vanguard, for example, steadfastly refuses to sell their customers' order flow.
With many Vanguard brokerage accounts also probably holding Vanguard funds (and thus being Vanguard owners), they'd be cheating their own owners out of their money while giving a big cut to the other party. That wouldn't make much sense.

Iridium
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Re: Robinhood Is Making Millions Selling Out Their Millennial Customers To High-Frequency Traders

Post by Iridium » Tue Sep 11, 2018 3:49 pm

Does this actually matter to Robinhood's customers? By regulation, Robinhood investors are getting no worse than the best market quote (in fact, they probably get some miniscule fraction of a cent extra). If some HFT wants to 'skip the line' by giving Robinhood a kickback, the folks hurt would seem to be those with limit orders resting at the exchange who got skipped over, rather than the customer.

Speaking of which, how do limit orders work with dark pools? I thought that limit orders were required to be put into the order book of an exchange if they cannot be executed immediately, so why are HFTs buying those orders?

Nummerkins
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Re: Robinhood Is Making Millions Selling Out Their Millennial Customers To High-Frequency Traders

Post by Nummerkins » Tue Sep 11, 2018 11:26 pm

Vanguard Brokerage routes primarily though HFT firms.

https://vrs.vista-one-solutions.com/sec ... entid=VANG

According to this document Vanguard is not paid for order routing, but by using these firms they expose customer orders to HFT front-running.

https://personal.vanguard.com/pdf/v719.pdf

I wonder why they don't use IEX which eliminated HFT on trades routed through them?

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Re: Robinhood Is Making Millions Selling Out Their Millennial Customers To High-Frequency Traders

Post by afan » Wed Sep 12, 2018 6:26 am

It is difficult to imagine what individual investor should be doing active trading of individual stocks. If such people exist then Interactive Brokers should be their company.

For everyone else, they should be buying either mutual funds, priced at the days close, no HFT games or liquid ETFs with one cent spreads and no commissions.

Not sure who needs Robin Hood.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

ftobin
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Re: Robinhood Is Making Millions Selling Out Their Millennial Customers To High-Frequency Traders

Post by ftobin » Wed Sep 12, 2018 11:49 am

Iridium wrote:
Tue Sep 11, 2018 3:49 pm
Speaking of which, how do limit orders work with dark pools? I thought that limit orders were required to be put into the order book of an exchange if they cannot be executed immediately, so why are HFTs buying those orders?
Limit orders work the same on dark pools. Only ordinary non-marketable retail client limit orders are required to be on an exchange. I don't know which orders you're referring to as HFT's 'buying'. The article didn't refer to dark pools.

As a side note, I definitely want my order shopped around before it hits the street, because it gets me a better price (presuming agreements disallow info leakage, no lost opportunity cost, yada yada). I don't care who is on the other side of the trade.

Starfish
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Re: Robinhood Is Making Millions Selling Out Their Millennial Customers To High-Frequency Traders

Post by Starfish » Wed Sep 12, 2018 12:22 pm

afan wrote:
Wed Sep 12, 2018 6:26 am
It is difficult to imagine what individual investor should be doing active trading of individual stocks. If such people exist then Interactive Brokers should be their company.
I actually think that it is very useful experience for some people.
I was a day trader for an year and a half, I made decent money, and I learned a lot of things.

cheezit
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Re: Robinhood Is Making Millions Selling Out Their Millennial Customers To High-Frequency Traders

Post by cheezit » Wed Sep 12, 2018 12:25 pm

ftobin wrote:
Wed Sep 12, 2018 11:49 am
As a side note, I definitely want my order shopped around before it hits the street, because it gets me a better price (presuming agreements disallow info leakage, no lost opportunity cost, yada yada). I don't care who is on the other side of the trade.
IMO the jist of the article is that Robinhood is getting a premium for order flow from HFT firms that is so large compared to what the firms give other brokers that the most plausible explanation is info leakage to enable frontrunning.

Of course, I have no idea whether this is correct, and since I don't trade stocks I don't deeply care.

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Re: Robinhood Is Making Millions Selling Out Their Millennial Customers To High-Frequency Traders

Post by indexfundfan » Wed Sep 12, 2018 1:50 pm

I have been getting price improvements from Schwab and Vanguard. I guess you won't be getting these at Robinhood.

Image

https://www.schwab.com/public/schwab/ac ... mprovement
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ftobin
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Re: Robinhood Is Making Millions Selling Out Their Millennial Customers To High-Frequency Traders

Post by ftobin » Wed Sep 12, 2018 9:32 pm

cheezit wrote:
Wed Sep 12, 2018 12:25 pm
IMO the jist of the article is that Robinhood is getting a premium for order flow from HFT firms that is so large compared to what the firms give other brokers that the most plausible explanation is info leakage to enable frontrunning.
If they are allowing information leakage they would likely be violating securities regulations. They are probably being payed more than other brokers because their users/toolset likely make the trades less capable of timing the market well.

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Re: Robinhood Is Making Millions Selling Out Their Millennial Customers To High-Frequency Traders

Post by stlutz » Wed Sep 12, 2018 11:32 pm

I have been getting price improvements from Schwab and Vanguard. I guess you won't be getting these at Robinhood.
Not true. You can (and will) still get price improvement at Robinhood. They aren't any different from Schwab who also receives payments for order flow (Fidelity and Vanguard do not).

There must be a ton of volume on Robinhood if they are making "hundreds of millions of dollars" from selling order flow. Or the article is wildly exaggerating.

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Re: Robinhood Is Making Millions Selling Out Their Millennial Customers To High-Frequency Traders

Post by HappyWorkerBee » Thu Sep 13, 2018 8:13 am

This article does a decent job of explaining what's going on here:
https://seekingalpha.com/article/420576 ... llain-made

If you don't want to read the article a short summary would be that Robinhood is paid more than other brokers for their order flow because they don't attempt to do any internal order matching themselves, they route orders directly to other parties to execute. This saves the folks at Robinhood from having to correctly implement order matching logic (it's a non-trivial task to comply with financial regulations and by having other firms execute their orders a lot of this compliance is handled for them). This also provides them with a steady stream of revenue so they can offer their service to individual investors for free.

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Re: Robinhood Is Making Millions Selling Out Their Millennial Customers To High-Frequency Traders

Post by indexfundfan » Thu Sep 13, 2018 8:18 am

stlutz wrote:
Wed Sep 12, 2018 11:32 pm
I have been getting price improvements from Schwab and Vanguard. I guess you won't be getting these at Robinhood.
Not true. You can (and will) still get price improvement at Robinhood. They aren't any different from Schwab who also receives payments for order flow (Fidelity and Vanguard do not).

There must be a ton of volume on Robinhood if they are making "hundreds of millions of dollars" from selling order flow. Or the article is wildly exaggerating.
I don't have an account with Robinhood. But would any Robinhood user like to comment if they get price improvements?

Personally, my own experience seems to be that I am getting more frequent price improvements at Vanguard and Schwab compared to at Merrill Edge.
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Re: Robinhood Is Making Millions Selling Out Their Millennial Customers To High-Frequency Traders

Post by HappyWorkerBee » Thu Sep 13, 2018 11:57 am

indexfundfan wrote:
Thu Sep 13, 2018 8:18 am
Personally, my own experience seems to be that I am getting more frequent price improvements at Vanguard and Schwab compared to at Merrill Edge.
Unless you're doing a lot of trading, your experience is likely subject to small sample size bias. I was in the (un?)fortunate position of having to trade out of a large volume of stock in a single company, a process that took many days to execute. I found that the frequency of price improvement for any collection of orders varied widely. As a result, if I'd only looked at one day worth of trading (~200 orders) I would have concluded that I got lots of price improvement with one particular broker, but if I looked at a different day with just as many orders I would have concluded that the opposite was true.

At least on the surface, Robinhood seems to be marketing their product to folks for whom getting free trades is more valuable than getting price improvement on their trades (specifically, to people with only a small amount of money to invest who most brokers don't give free trades to). It's likely their customers rarely if ever get price improvement and that money is instead used to fund operation of the service.

The only other place Robinhood seems to make money is by charging interest on margin. Quite honestly, I'd rather they fund their service with payment for order flow and price improvement rebates than by loaning people with little money cash to buy stocks.

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Re: Robinhood Is Making Millions Selling Out Their Millennial Customers To High-Frequency Traders

Post by alec » Thu Sep 13, 2018 1:24 pm

HappyWorkerBee wrote:
Thu Sep 13, 2018 11:57 am
indexfundfan wrote:
Thu Sep 13, 2018 8:18 am
Personally, my own experience seems to be that I am getting more frequent price improvements at Vanguard and Schwab compared to at Merrill Edge.
Unless you're doing a lot of trading, your experience is likely subject to small sample size bias. I was in the (un?)fortunate position of having to trade out of a large volume of stock in a single company, a process that took many days to execute. I found that the frequency of price improvement for any collection of orders varied widely. As a result, if I'd only looked at one day worth of trading (~200 orders) I would have concluded that I got lots of price improvement with one particular broker, but if I looked at a different day with just as many orders I would have concluded that the opposite was true.

At least on the surface, Robinhood seems to be marketing their product to folks for whom getting free trades is more valuable than getting price improvement on their trades (specifically, to people with only a small amount of money to invest who most brokers don't give free trades to). It's likely their customers rarely if ever get price improvement and that money is instead used to fund operation of the service.

The only other place Robinhood seems to make money is by charging interest on margin. Quite honestly, I'd rather they fund their service with payment for order flow and price improvement rebates than by loaning people with little money cash to buy stocks.
Why do u think that Robinhood customers rarely if ever get price improvement?
"It is difficult to get a man to understand something, when his salary depends upon his not understanding it!" - Upton Sinclair

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Re: Robinhood Is Making Millions Selling Out Their Millennial Customers To High-Frequency Traders

Post by HappyWorkerBee » Thu Sep 13, 2018 3:27 pm

alec wrote:
Thu Sep 13, 2018 1:24 pm
Why do u think that Robinhood customers rarely if ever get price improvement?
It's just a guess based on:
  1. often there is price improvement to be had
  2. Robinhood needs to make money to pay to run their business
  3. Robinhood investors aren't going to notice / complain if they never get the price improvement, they're getting free trades, that's what they want.
Granted, it's possible Robinhood lets the market maker keep the price improvement, which would help support the higher payment for order flow that they're getting paid (and simplify their bookkeeping).

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Re: Robinhood Is Making Millions Selling Out Their Millennial Customers To High-Frequency Traders

Post by hdas » Fri Sep 21, 2018 9:02 am

Ameritrade not far behind: https://www.ft.com/content/96b92e56-2af ... 858a6aa07a
The court found that instead of requiring every single brokerage customer to prove harm from payment for order flow under the rule covering securities fraud, the losses for the entire class could be determined by “the same algorithm the defendant (TD Ameritrade) uses to route orders in the first place”.

This is big. If the court ultimately does determine that the customer class has been harmed, TD Ameritrade (and maybe other brokers accepting payment for order flow) could have to disgorge years of revenues from the practice, and, possibly, other penalties and charges.

If that happens, and the Klein v TD Ameritrade district court rulings are affirmed on appeal, it will be an existential blow to the current model for much of the retail brokerage industry in America.

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Re: Robinhood Is Making Millions Selling Out Their Millennial Customers To High-Frequency Traders

Post by arf30 » Fri Sep 21, 2018 9:10 am

So basically the investor doesn't pay a $5 commission to buy those 50 shares of stock, but the overall purchase costs them $5 or more overall because they pay a higher price in the market.

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Re: Robinhood Is Making Millions Selling Out Their Millennial Customers To High-Frequency Traders

Post by Potential » Fri Sep 21, 2018 9:47 am

afan wrote:
Wed Sep 12, 2018 6:26 am
It is difficult to imagine what individual investor should be doing active trading of individual stocks. If such people exist then Interactive Brokers should be their company.

For everyone else, they should be buying either mutual funds, priced at the days close, no HFT games or liquid ETFs with one cent spreads and no commissions.

Not sure who needs Robin Hood.
No one needs RobinHood. The type of people to use RobinHood are young and probably don't know much about investing. There are online communities on reddit with thousands of users speculating together.

I am 22 years old and some of my close friends use the app to 'invest'. They go on about their referral codes in order to earn a free share of stock [Randomly chosen from a pool]. They also talk about their 'wins' and how they should invest more money or perhaps pick their new favorite company to invest in.

Frankly, I don't believe they know anything about investing, I try to nudge them away from RobinHood but to no avail. None of my friends have a full time job, college degree, or any financial 'smarts' that I have observed. Some have 401k's but they don't utlize it much and would much rather use RobinHood.

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Re: Robinhood Is Making Millions Selling Out Their Millennial Customers To High-Frequency Traders

Post by HappyWorkerBee » Fri Sep 21, 2018 12:53 pm

arf30 wrote:
Fri Sep 21, 2018 9:10 am
So basically the investor doesn't pay a $5 commission to buy those 50 shares of stock, but the overall purchase costs them $5 or more overall because they pay a higher price in the market.
In a word, no.

If someone buys 50 shares of stock with a limit price of $10 and the stock is liquid so the bid/ask spread is small, they might get price improvement so their trade executes at $9.995 instead of at $10. There's $0.25 of price improvement on the trade (50 shares * $.005). It's also worth pointing out that price improvement is not available on every trade. Some trades have price improvement, many do not. So this fictitious Robinhood user may or may not be missing out on that $0.25, but either way they're definitely saving the commission cost.

In order to get $5 worth of price improvement on a single trade, you'd either need to be buying/selling a very expensive stock and/or you'd need to be buy/selling a whole lot of shares at once. For example, GOOG is currently at about $1,176 and the bid/ask spread is about $0.34, so you'd need to be transacting 30 shares with $0.17 of price improvement for each in order to get more than $5 of price improvement.

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Re: Robinhood Is Making Millions Selling Out Their Millennial Customers To High-Frequency Traders

Post by triceratop » Fri Sep 21, 2018 1:18 pm

I'm a skeptic of this story---it's convenient to blame Robinhood and say customers are getting a worse deal. But if you dig into market structure a bit, it's less clear, and possibly even points in the other direction. HFT firms want to avoid adverse selection which is easy to do with retail investors who are not likely to be making informed trades. Therefore, they should be willing to offer better execution to retail customers because we aren't really tipping our hand about any near-term price action. Institutional investors are the ones who lose here.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

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