The argument is that; PFOF is supposed to be good for retail investors and not a means for front running your trades.
But, as any dream invested in children, the child usually grows up to be a disappointment. Atleast, in a cynical sense.
This incredible man named Bernard Madoff re-invented many schemes, one of which is pioneering Payment For Order Flow (PFOF). He didn’t actually invent it since it’s been around sense the 1980’s, he just made it really popular.
Rest in Peace,
April 29, 1938 – April 14, 2021
Bernie Madoff may he rest in peace. He even defends PFOF, and to his defense, he’s not necessarily wrong. You see, morally and financially, his argument makes a lot of sense;
“No one tells a firm how they can advertise. If I want to hire salesmen to generate order flow, no one is going to object. I don’t have them. So if I want to use Fidelity’s salesmen and pay part of my trading profits in the form of a rebate, why shouldn’t I be allowed to do it? It was characterized as this bribe and kickback and something sinister, which was very easy to do. But if your girlfriend goes to buy stockings at a supermarket, the racks that display those stockings are usually paid for by the company that manufactured the stockings. Order flow is an issue that attracted a lot of attention but is grossly overrated.”
The part that he is someone wrong about, is that the supermarket isn’t owned by the public. So equating the lit exchanges to the super market, is sort of wrong and inaccurate. Because the Super Market itself is a monopoly, as to where the Public Stock markets aren’t supposed to be. . . But, as we’ll find, the advent of PFOF and internalization has just privatized the stock markets. Which in turn creates inherent conflicts of interest resulting in a not-so-honest trade and a not-so-honest market. You know, a scam.
So after the whole GFC of 08, Mr. Madoff’s tech got reappropriated and acquired by market makers and the DTCC. It was such an interesting model and financially lucrative, that other market makers and brokers started doing it too. Yep, So now a good chunk of the stock market uses PFOF.
So what is PFOF?
Here’s an old Infographic,
KCG got bought out by Virtu
So replace KCG with Virtu Financial, lmao
I personally use the term ‘Market Maker’ instead of ‘Whole Saler’, just a personal preference, and I’m not too keen on if the nuance and semantics really matter. So I’m just going to use Market Maker instead.
PFOF is a system in which an exchange or market maker will pay other brokers and market participants to route trades to them.
Essentially buying the order information and giving a ‘rebate’ back to the market participant that sold it.
This could, in theory, get better prices for everyone. The person who buys or sells shares could get a price improvement, the broker gets a rebate, the Market Maker gets to make money between the Lit exchange spread, technically everyone wins.
This is in theory, how people could make a lot of money and everyone technically could win.
But we’re no longer in the 20th Century Ideals of Win-Win scenarios and ‘you profit, I profit’. No. Instead, this system could also result in obscuring the market and result in a very negative detriment to actual Price Discovery. Because what ends up happening is things go off the books, off the exchange.
So let’s discuss a real example of a PFOF relationship to understand more;
We can see this beautiful relationship happen with Robin Hood and Citadel Securities;
You know, the Same Robinhood that gained prominence in 2013, just a few years after the demise of Madoff’s PFOF system in 2008. Coincidently enough.
Investor buys or sells a security. They place that order on Robinhood through their mobile gaming app. That order goes to Robinhood.
Robinhood can either Fulfill it from their shares that they have internally in the Continuous Net Settlement system, called Internalization, or they can send it to the Exchanges like the NYSE to get fulfilled.
Instead of doing either of those, Robinhood gives the order flow to a Market Maker like Citadel.
Citadel offers a ‘rebate’ which is essentially paying Robinhood. So Robinhood is essentially selling Order flow and routing it through Citadel. The rebate (may) comes from Citadel making money by ‘capturing the spread’ and trading in-between the spread (The spread being the difference between the buy price and the sell price).
How much is that rebate?
Reportedly, Robinhood has made the majority of their revenue from selling order flow, several millions worth.
Some reports peg close to a billion dollars worth from PFOF. Interesting;
Some other reports say Robinhood get’s paid a few big bones;
Here’s a Case report
-explaining more about the relation between Citadel and Robinhood;
So Robinhood takes the trades from your Degen Millenial and ships it to a Market Maker like Citadel for a rebate or a kickback.
What the Market Maker does is either they fulfill the order in the open market, or they internalize the trade to provide an ‘inside price’ that is different from the NBBO or the public price of a security. So instead of taking that order to market, they trade with what they have in their inventory. That’s the basics to internalization, but that too is a can of worms.
That’s “internalization”, and if you have questions about that big word because it’s a big word, then click here to learn more.
And it’s a known thing that Market Makers like Citadel and Virtu love to internalize trades to offer ‘price improvement’ and ‘provide liquidity’ like a liquidity fairy.
But also, Market Makers have been known to take a mark to market loss on externalizing their trades to the open market;
So if the Market Makers lose money for routing trades to the lit exchange, then the Market Maker is incentivized to try and keep the trades in house. Meaning that the Market Maker is going to probably Internalize the majority of trades. It’s just good business.
Another profit model for Market Makers is;
That they take the other side of the trade and are the counterparty. Which is part of the internalization, but there’s more to just ‘providing’ a share.
So if you are a retail trader and you buy a share, the Market Maker might sell one short, or sell a share borrowed from an ETF or a mix of Swaps and Options. Point is, they take the other side of the trade. It takes two to tango, and it takes two people to trade. if there’s a buy side, then obviously there is a sell side.
Statistically speaking, Retail traders tend to lose. I blame the system and the rigged markets.
But whatever the reason Retail traders lose, it seems almost safe to bet against the retail traders. Well, atleast it seemed that way for a long while. The Street calls em’ “dumb money” for a reason. So statistically taking the delta hedging opposite position of trades could help net you some wins.
This is the other potential with internalization. Not front running, but just ‘early access’ or ‘sneak peak’ at a future loser.
Retail traders lose money, the internalized Market Maker makes money. It’s a win. On top of that, the market maker didn’t really have to pay full price for a share, using the swaps, options, or short sell. So Market Makers make more of a win. The ‘smart money’ is betting on retail traders selling for a loss, paper handing. But they also have other tools and tricks to ensure the price goes in their favor. So, diamond handing things won’t guarantee a win.
Another cool feature with this is; Market makers could fulfill buy orders with short sold shares and delay buying the actual shares. This is the legal market maker exception. It inherently means they are racking up extreme short positions in the stocks they are routing orders for. Which is exactly what happened with Citadel during the Robinhood fiasco. Essentially the Trade volume was too much for Citadel to handle internally, that Citadel had a huge short position and their risk management didn’t approve. So Citadel had to limit or prevent PFOF to stop having orders be sent to Citadel.
And that’s what may have happened, Citadel demand limiting PFOF to it’s Order Flow Providers, or the Brokers.
Because if Citadel couldn’t internalize the trade, then Citadel would have to send it to the lit market, and they would take a Mark-to-Market loss on each share. We’re talking near billions of volume, that’s quite an ouch. Quite the loss. Not good business.
What can happen hypothetically,
This is speculation, of course, and possible.
Is that these Market Makers could front run trades off the lit exchange.
Getting ahead of the trade in their own private Dark Pool or ATS and fulfilling the order at a ‘price improvement’.
Giving the Retail trader an ‘inside price’ instead of the NBBO. An inside price that is disadvantageous and worse off than the NBBO.
So your orders don’t affect the actual price, doesn’t actually make it to NBBO, and doesn’t directly print to tape.
It might indirectly print to tape, but only after the ‘price gets improved’ by the Internalizer at their determined ‘inside price’.
This is, of course, me being cynical and foreshadowing the future with what you’ll learn in this Article.
What actually does happen is,
Instead of the Market Maker directly Front running you, the Trade data of the order flow gets sold to someone. A third party like a Hedge fund or some Quant firm. Someone that can use that trade data. . .
Why would someone want the trade data?
What can someone do with trade data?
Could they make money off of it?
The answer is, yes.
So, if the Market Makers aren’t internalizing and front running your trades that they bought. Then they’re selling your order flow trade data information. They’re selling it to someone else who can use that data.
If they use that data, they might use that data to reinforce your positions, or even trade against them. I mean, why else would some hedge fund care about the trade data? They’re in the markets to make money, not some altruistic pure research for economics’ sake.
That’s not in the best interest of Retail. Yea, so the chances of PFOF order flow being traded against is very high. It’s not guaranteed to be traded against, but it’s still very probable. Meaning that Market Makers sell trade data to someone who is going to trade against that very same order flow that was processed by the Market Maker. Meaning Retail traders are getting played.
But What about a Price Improvement?
So, the idea is that the Market Makers who buy the Order Flow use that to hit the market. What can happen though, is that they trade internally and just eat up trades using their own inventory or shares or some like-kind collateral.
In the ideal world, the Market Maker would try to squeeze in your order in-between the spread at a price advantage. For instance, if a ticker of $FUZZY has a spread of say bid $10 and ask $11. Then the Market Maker can take your order, and try to get it close to your asking price.
One perk of a market maker is that they get access to more digits and significant figures.
“In lit markets, investors see prices in one-penny increments. Wholesalers, though, can fill orders at sub-penny prices and without open competition.
More than half of the share volume in the first five months of this year was in stocks constrained by tick size. In contrast, sub-penny trading, including at a tenth of a penny, accounts for 37 percent of share volume executed off-exchange.
Given this activity, I wonder why lit markets should have that one-penny constraint. It raises real questions about whether this structure is fair and best promotes competition. Why not allow all venues to have an equal opportunity to execute at sub-penny increments?”
-Gary Gensler SEC Chair
So in theory, they can make a lot of money by shaving a small percentage off of every trade, and give that rebate back to the broker that sold the order flow. And in theory, you could get a ‘price improvement’ from the current bid and spread. So instead of buying at $11, you might buy at $10.9535. They’ll round up and take $10.96 cents from you, and then split the difference between the Market Maker and Broker (In this case; $10.96 – $10.9535 = $0.0065)
And you might think that a 0.65 of a penny ain’t much, but imagine if you’re trading volume in the millions or billions. A 0.0065% of a Million dollars is still $6,500. And that’s with a volume for a million trades. In a day, there can be several million trades just for a single security. Imagine how many securities are out there- that’s a lot of trades.
Here’s an Office Space reference explaining fractions of a penny.
And here’s a Wolf on Wall Street reference explaining how to make more money on commission.
So these guys are giving you a price improvement, so much so that Brokers can offer ‘commission free trades’. Meaning that the PFOF model is so lucrative, that they can place an order for you without charging. So instead of charging you a fiver to place a trade for say 100 shares or so, they can charge you fractions of pennies on those 100 shares. Now, it may sound like they’re losing out, but they’re actually winning more because of a few things;
-The Brokers get paid via a kickback or rebate from the Market Maker
-The Brokers can also sell your data, technically by selling your order flow, they are actually selling your data
-Your information or data can be front ran and exposed to people with HFTs that can undercut you
And because of the PFOF model, that means not a lot of the actual orders hit the market. And because less orders are actually hitting the market, you get larger spreads between bids and ask.
So instead of buying that $FUZZY with a spread of $10-$11. Now that spread is bigger, meaning that the spread could be $9 to $12. So instead of getting a market order price improvement of $10.96 per share, you might get a ‘new’ price improvement of $11.96 per share. Yea, you end up paying more but it’s sold to you like it’s an improvement.
Here’s the same thing with psychological sales manipulation;
Black Friday sales reminds me how much I disdain Consumerism
So larger spreads means that market orders can be met somewhere in-between making the possibility that your orders are actually a price un-improvement. The price improvement you get might not actually be an improvement at all.
Just quite possibly, Retail Traders don’t benefit from this whole ordeal. Heck, even the rebate kickback scheme doesn’t help out retail traders;
“Exchanges give rebates to traders. High-volume traders benefit more from these arrangements, and retail investors don’t directly benefit from those rebates. Just as payment for order flow presents a conflict of interest in the routing of marketable retail orders, exchange rebates may present a similar conflict in the routing of customer limit orders.”
–SEC Chair Gary Gensler
And it was alleged, that Robinhood didn’t share the love of the gains they got from the rebates at a proportional rate to traders;
So if someone could do an 80/20 split, what’s stopping them from doing 100/0 split? I’m simply asking questions my boy-o.
How much of orders are internalized?
So PFOF happens, and sometimes a Market Maker buys those orders and they trade within their own inventory using their ‘desk’. Which is just a roundabout way to say ‘in house’. That’s internalization.
The exact numbers are probably out there on some report somewhere. It’s not clear to me, but about more than 90% of retail orders are executed off exchange in Dark Pools. An estimated 30%+ of all trades are executed in Dark Pools. But the thing is, reporting practices in Dark Pools aren’t so transparent, or else they wouldn’t be called ‘dark’ pools (as opposed to the ‘lit’ exchange).
“What’s more, 90-plus percent of retail marketable orders are routed to a small, concentrated group of wholesalers that pay for this retail market order flow.”
–Gary Gensler SEC Chair, using Data from Rule 606
Here’s the same thing but in Tweet form;
-The Chair of the SEC (as of writing),
So yea, we’ve obscured the market and price discovery all for some gamified price improvement that shaves pennies.
Let me rhetorically ask you this, if someone is paying others to do something, then certainly the reward must be worth the risk. The risk here is guaranteed that someone is losing cash in payment, hence the paying others to do something. So the reward has to beat a guaranteed lost. That’s Cost analysis 101.
What that means is, the Market Makers are able to perform PFOF and still come out on top. That means they are profiting. They wouldn’t take a guaranteed loss to not make money. They’re business model is on making money. The customer getting a price improvement, no matter how little, is just a collateral that may or may not happen.
You think these Market Makers and Financiers on WALL STREET of all places gives a rat’s ass about being altruistic and benefiting the average retail trader? Ha, fat chance. I’ve seen more Altruism in a soup kitchen than having some Hedge Fund Manager talk about ‘Price Improvement’ like he’s not trying to fleece over ‘dumb money’. Them getting on Television to ‘worry about mom and pop retail traders’ is a show, a farce, a scam.
If you honestly think someone is going to help retail traders make money, then I ask you this. Who are retail traders going to make money from? Money has to come from somewhere, if money is gained, then money is lost. And I guarantee you that the majority of the markets don’t offer profit sharing revenue in the form of dividends for share holders.
Let me pose another question;
Where are all the Retail Trader’s Yachts?
Certainly there might be one or two, but the majority of the people in the various Yacht Clubs that dot the US Continental East Coast- if they have their foot in the Stock Market, chances are they’re not retail traders.
Ultimately, you could reasonably say that;
“The high-frequency traders succeeded in diverting nearly the order flow from the public exchanges, and as a result, the public exchanges have become less liquid, and the bids and offers have become wider.” -Someone who owns a brokerage
So if liquidity providers are actually making the lit and public exchanges less liquid. Doesn’t that mean they’re providing less liquidity? That Liquidity providers are doing the opposite?
What happens when you give someone the authority to, say, put out fires? When they become the sanctioned monopoly, what happens if they decide to, look the other way? Won’t you have more fires? That’s exactly what happened when Fire fighters were private companies running their own Fire Brigades that became a glorified gang extorting victims as their houses burned down. I’m talking Gang’s of New York time. “Pay up or your house burns down”, essentially.
That is the problem with an entity that is a private entity, like market makers, that are tasked with providing liquidity. They have the ability to control liquidity, meaning they control volume, and all of these levers helps to control prices in the Stock Market. They get tools and extra ‘privileges’ to leverage and extort the market mechanics to favor themselves.
It’s highly probable that these market makers are gaming the system when there is literally less liquidity in the markets. Like wasn’t that your job? To provide the liquidity? Idk famm-o, seems like a scamm-o.
“Due to the lesser liquidity in the public markets, more, and more institutional traders do not want to show their orders publicly because they don’t want to push the markets against themselves. So instead they provide brokers with their orders that we are keeping in the dark(pools), but we trade them against the order flow we get in so that many of these executions take place at the mid-price, and that is a good thing, and that is now a slowly evolving trend” -Someone who owns a brokerage
So, with less liquidity, the price swings more drastically on any small amount of volume. Small being relatively 10,000 or so shares. Meaning that large funds and people with large block orders, have to re-route to market makers to chop up their trades and not expose their hand. So these funds route to Brokers who, well, can trade against them.
But if they route direct to the market, then they have to do it at a trickle rate or expose themselves. And when it comes to the market, time counts, time is money. So executing a trade of 10,000 or a hundred thousand shares over one trading week, isn’t going to work especially if there’s price fluctuations. That’s like slowly backing out of your driveway onto a highway where everyone is doing 70 Miles per hour. You’re fucked.
That’s essentially what money managers and funds have to consider. Whether they route to open market and expose themselves, or trade very fucking slowly. Or route to a Brokerage and Market Maker, to obscure their trades, and possibly lose or gain a bit of money depending on the rebate and ‘price improvement’. Something that the Fund can’t verify themselves.
As a side note, this is sort of what Crypto Currency is supposed to help with. Providing an open and public ledger so everyone can identify and see things forever. Just so you know that you’re not getting fucked with. But crypto has it’s own problems, and you can thank the Bank Jocks for that.
Here’s how PFOF can alter Price;
This is speculation and conjecture, but it’s highly possible. It may even be probable, because profit. This is of course, Market Manipulation.
So the Order flow is routed to a market maker, that may internalize the trade. If you buy shares in a stock and it goes to the Market Maker to fulfill, they can decide to fulfill it internally or fulfill it on the lit exchange.
But here’s the catch, they get to decide what to do with your order as long as you get a decent price within your price target or market order spread.
Since the Internalization isn’t reflected on the NBBO, we know the NBBO is fake.
And Since Market Makers can be ahead of the trades with routing the order flow to them, they can help ‘guide’ the market to a certain direction. To help ‘move’ the price either up or down depending on how they feel. You know, good old market manipulation.
So, the Market Maker could look to see the spread and run an algorithm that adds increased buy or sell pressure.
For instance, if X Stock has a huge spread of $100 to $200. Let’s say there are three buyers, one buyer wants to buy at $110, one buyer wants to buy at $120, and one buyer is okay to buy at $130.
A Market Maker could exert sell pressure by internalizing the buy orders at $130 and $120, and letting the $110 hit the market. Thus creating the illusion of low demand and low resistance or support levels in the market. This stresses the price to be closer to the $100 or $110 mark.
Inversely, a Market Maker could exert buy pressure by internalizing the buy orders at $110 and $120, and letting the $130 order hit the market. Thus creating an increase in demand and raising the resistance or support levels in the market. This stresses the price to have a spread of $130 to $200 instead of $100 to $200.
It is to note, that Market makers get to play both sides of the trade. They get to route buy orders as well as sell orders, so they have more control over the direction of price based on this.
And I use cartoonishly large spreads, because I need you to understand that a penny difference is cartoonishly large for a Market Maker who can see fractions of a penny. So the Market Maker can use their HFTs to push the underlying security down with illusionary sell pressure by intentionally not providing liquidity. Or push the security price up with illusionary buy pressure with the artificially scarce liquidity.
And these spreads can happen especially if people place market orders. Market Orders essentially give Internalizers a payday by allowing them to sort of decide and giving them a lot of wiggle room. Because Market Orders that abide by the NBBO spread, you’re basically giving Internalizers the go-ahead to pick any price they want between the spread. Yay.
This is one, of many ways that an Internalizer with PFOF can manipulate prices.
Some Criticisms of Robinhood;
Because of the Model that Robinhood has with PFOF, they are incentivized to increase the number of trades rather than ensuring the protection of their investors from being gambling degenerates. Thus, Robinhood has been accused of gamifying their app, using confetti, reminders, fanfare, and even free stocks as a way to DLC-Season-pass the activity of Stock Trading.
And there’s criticisms with the specific PFOF result;
It seems there’s an inherent conflict of interest, because Robinhood is getting paid more to route their order flow, and thus is getting paid to increase the number of trades. Also, they get paid based on the spread, so the larger the spread, the more they get paid.
If you don’t know, Robinhood’s app has a list of advertised tickers and announcements of moving tickers and stocks. It’s like if StockTwits and a Bloomberg terminal had a retarded baby. That’s (my opinion of) Robinhood. So they advertise, sort of, other tickers on their platform. Almost like aimed or targeting advertisements to promote certain securities.
And because Robinhood is incentivized by the PFOF model to promote stocks with less liquidity, higher spreads, and more obscurity, resulting in an influx of probably penny stock degenerate gamblers. All the while, profiting more from doing so.
You might be like, ‘so what’. Well, historically, Penny Stocks are manipulated;
And there’s plenty more examples out there
So Robinhood is essentially luring investors into something that would be primed for manipulation by Predatory Market Practices.
I am not saying that the underlying company is bad or fraudulent, I am saying that the market itself is predatory and fraudulent, and that it is easier to manipulate a penny stock security than other tech stocks or large cap stocks that are manipulated by larger institutions. Everyone and everything is manipulated in the markets, technically speaking.
It’s just Harder to rock the boat in a large cap security when it’s being funded and backed by banks. You think you can push over big tech with big tech money? They’ll fire back. It’s like a gang war with money guns firing cash and tickers instead of bullets. Enjoy that analogy.
It’s just gambling, which, Idk if Robinhood Investors are actually investing or just playing the lottery. So it’s partly deceptive. But it’s also the fault of the Retail trader for being, well, a degenerate too. So everyone gets a little blame.
On the flip side of the coin, having more trades in a less liquid stock, actually provides liquidity. So it’s sort of doing the market a service. Sort of, kinda. It’s like good, but it’s not necessarily good for retail traders.
Here’s some conclusions that sums up some of the above stuff based on an SEC report;
Some Criticism on the Market Maker;
Robinhood uses Citadel Securities as their Market Maker, or wholesaler, to route the Order flow.
And it’s known that there are several actions on Citadel for HFT front running trades and some other issues. Actions being a loose word for allegations that they neither admit or deny.
Whoops, a $700k fine for an issue that may or maynot have happened 8 years before they were fined.
Now this doesn’t specifically make Citadel out to be a monster. It’s just that they were accused of false advertising and had two algorithms. One that just filled the order as quick as possible, and the other algo just didn’t obtain the best price. These two algorithms are a very small part of their whole operation, like very very small, but it still amounted to a $22.6 million fine. Kind of makes me wonder if the other larger part of their operations were to be equally bad, what would that fine be? Hundreds of millions? Just a question.
And also, these two algos were old discontinued algorithms. They were discontinued in 2010, but we fined them in 2017. Is that a win? 7 Years after the false advertisements and damages already done from not providing price improvement?
So what about the current Algorithms? The Current Operations? Well, maybe something else is going on? It’s speculation.
The real shady part would be asking questions about whether the Trade data from Order Flow is being used and sniped by Citadel Securities and their Hedge fund that is also named Citadel.
So it’s not entirely impossible for a Market Maker like Citadel Securities or Virtu Financial to buy order flow and trade against the same order flow. Essentially front running and leveraging the trade data they get in.
Or selling the trade data to someone else to front run and leverage. So, what’s really happening behind the scenes? What goes ‘bump in the night’ in the darkest of dark pools?
If you think about it, Citadel is the customer buying from Robinhood, Citadel technically doesn’t have an interest in whether or not the Degen trading on Robinhood gets best execution. Technically speaking, Citadel bought a product and can technically do what they want within the current rules and regulations of the current system. Technically.
It’s very well within the realm of possibility.
Criticism of Market Maker and Broker relationship;
As it turns out, Brokers aren’t supposed to fleece over retail traders that use their service. But because of the profitability of PFOF, the Brokers are incentivized to max out PFOF.
The Market Makers that gain the Order Flow either trade against the Orders or sell it to some firm that can trade against the orders. So the Retail trader is susceptible to gettin’ the short end of the deal.
Meaning, if more Brokers than Robinhood also Collude with their PFOF Market Maker, then you could start a PFOF Cartel that extracts wealth from doing something like front running trades or dicing them up with HFTs.
You ever heard of RICO charges? Idk about you, sounds like there’s a Cartel a brewing out there.
Anyways, here’s a Open Letter
From Citadel saying why PFOF should be banned in 2004;
“Internalization without meaningful price improvement” is bad. Now the problem we face in the current markets is, who gets to quality check whether or not anyone is getting a ‘meaningful’ price improvement? It definitely limits price discovery. It Definitely leads to market fragmentation.
Here’s some more words by Citadel;
The Payers for PFOF would result in ‘wider spreads’ or a reduction in other ‘benefits’ that could go, should go, and be provided to customers. Those benefits are things like ‘price improvement’ or ‘price discovery’. . .
It’s to note that Bernard Madoff didn’t have his financial troubles until 2008, in which Citadel adopted Payment For Order Flow to be used with Robinhood’s Commission Free Trading, which started in 2013. Interesting timing, one music stops and the other starts playing.
And it’s also estimated that about 40% or more of the market is handled by Citadel Securities. Bernard Madoff at the time had about 9% of the Market.
So there’s definitely a lot of money.
Benefits of PFOF,
If you want to obscure your trades and not expose yourself on the lit market, then you can place a large order, watch it get diced up into smaller pieces, and then trade in odd lots on the lit exchange. Thereby no one knows if your huge order was a single investor or many investors.
This is a way to hide Iceberg trades and not ‘expose your hand’ in trading. Most investment firms have internal procedures, or rules, or even algorithms to help position their trade to slowly enter or exit a position. You don’t want to unwind all at once or such, because that could cause a market anomaly and allow for people to buy the dip, or further short the dip, sell the tip, or degen the rip. Many speculators and small fish will go to help smooth out the Priceline and recoup some alpha that you undoubtably left behind leaving in a hurry.
For instance, if you sell immediately 1,000 shares of $FUCK, and there’s only so many buyers at a specific price, then you can only sell so much before the price goes down. Same with buying, there’s only a limited amount of sellers. Unless of course, you have a Liquidity fairy providing the Delta or building paper walls of faux resistance to limit your trades. People don’t want to sell shares for a lower and lower price, similarly, people don’t want to buy their shares for a higher and higher price. Having a large Iceberg of a trade, or a block trade, would obviously cause too much price fluctuations and result in ripples.
These benefits are also similar to those that you can get from routing through a Broker or Prime Broker using an OMNI-Bus Arrangement account, in which they just lump your shit with everyone else’s.
So the Benefits are for the lazy, more anonymity, for speed, and maybe a slight price improvement if the Internalizer isn’t fucking you over. Ha, big chance. I don’t see no Customer Yachts over here.
But if your goal is to cover your trades and obscure them, then you probably have a lot of money and you should just pay for an ATS or some other Alternative trading venue services like a Dark Pool. It would essentially do the same thing, and you might get more preferential treatment, seeing as you’ll be the customer instead of the product. Maybe, just maybe though. No Safe Bets.
The Banning of PFOF;
Payment for order flow is technically banned in Canada, UK, Australia, and Europe.
But that doesn’t mean there aren’t ways around it.
Let’s say you put in an order and it gets fulfilled on US Soil, but it’s internalized on US Soil. Did you break any other laws? Idk. I’m not a real lawyer.
Do I personally believe PFOF should be banned? Idk. I personally don’t like the idea of internalization, fragmentation of markets, and front running trades, and not even having any trades reach the lit exchange.
Honestly, if there was open reporting, I don’t think a lot of people would care too much. As long as that meaningful price improvement was guaranteed and reflected in the open markets, then maybe it’d be a good thing. So yea, if PFOF is open and honest, then there’s not a really big downside to PFOF.
But that would require the people profiting from larger spreads to, well, profit less. -And that’s probably not gonna happen, toots.
Before you know it, you’ll ask for things like ‘no conflicts of interest’. Ha, fat chance.
So chances are, people that profit from PFOF are going to lobby in defense of PFOF meaning that PFOF is unlikely to get banned. Even if the SEC says ‘it’s on the table’. PFOF at the least should be modified or better regulated so everyone actually wins?
A Counter opinion for Market Reform;
I’m just not a fan of the Duopoly. The Citadel and Virtu of the world.
I think if we had more market competition then we wouldn’t have to worry so much about manipulatory practices happening across the board. Meaning I would like MORE fragmentation of markets.
If Hedge Funds and firms only had to buy Trade data from one or two sources, Virtu or Citadel, then they’ll have all the data they need ish. -But if they had Fifty sources where they could buy trade data, then it’s not so simple to easily predict the future or market. Simply because they won’t have all the data they need. They would need to justify buying multiple streams of data, which may or maynot be cost effective. So market manipulation and front running becomes harder and takes more skill than systemic design.
Creating more of choice, rather than the illusion of choice, allows for the markets to be more fair. Not letting one single participant get the whole or full picture, would be the fairest thing you could do.
So, basically, if we had more anti-trust in the markets, breaking up the duopoly, then there would be a more fairer playing field, because everyone would be trading in the dark and not knowing anything. This is a totally counter intuitive approach, and a theory, to how dark pools, internalization, and fragmentation of the markets could benefit the average trader.
But it also opens up to more problems too, so this is just a small step in possibly the right or wrong direction.
Because of SLPs and dark pools internalizing trades and the HFTs technologies and algorithms and other tech that can outrun, out-process, and dice up trades. Chances are, you as a retail trader or small firm are gonna get hurt.
The public exchanges (NYSE, NASDAQ) have become less liquid. In other words, volume as a whole is drying up on the public exchanges. Bid-and-ask spreads widening is a symptom of lower volume. Wider spreads means more money for Internalizers, meaning the PFOF model is profitable. So Internalizers that use PFOF are incentivized to widen the spreads and not provide liquidity. . . Even though they may be nominated or certified to be ‘Liquidity providers’. I shit you not.
The majority of retail trades are going through PFOF and are being internalized and traded against, never seeing the light of the lit exchange.
Chances are, Retail Traders aren’t getting a price “improvement” at all. It’s more of a technicality if they use that term. Really it’s a price adjustment, and it might actually be a price un-improvement.
Which also means that the ‘Brokers are not your friends’ because they’re selling you as the product. If it’s ‘free’ then you’re the product.
So, as usually, Retail Traders are the Cash Crop or Cash Cow that gets farmed in a Matrix system by Megalithic Market Architectures and robust structures using algorithms and High Frequency Trading systems and tech to siphon said wealth through various means from investment portfolios to even Pension Funds. Ah yes, Man made horrors beyond my comprehension, just my sort of tea.
This is Literally the current state of the Markets as of writing, so Enjoy,
*Not Valid Financial, Legal, Life, or Any Advice