Shocking! Robinhood CEO defends high frequency trading is to benefit everyday investors

19 Feb, 2021 07:32
source: Singularity Financial

Singularity Financial Hong Kong February 19, 2020 – Robinhood CEO Vlad Tenev defended the role high-speed traders play in modern markets “more efficiently process trades at a narrower band of prices. Among those who benefit? The everyday investor,” according to Tenev’s recent blog.

Today the majority of retail trading is not done on exchanges, it is done by market makers that “internalize” the trades. When your broker sends a stock or option order to a market maker, the third-party firm pays the brokerage to execute it. Also known as stock order routing, payment for order flow (PFOF) is the money a brokerage or investment app receives when they pay an outside firm to execute the investment buy or sell orders you gave them.

For instance, if you placed a buy order for 20 shares of Amazon stock with a brokerage that receives PFOF, your order will make a pit stop before it gets fulfilled. After you place the order, your brokerage will send it to a market maker who carries out the actual trade.

Your broker will usually have a prearranged agreement with market makers who will compete for the order flow. The bigger market makers include Virtu, Citadel Securities, Susquehanna, Jane Street, Two Sigma and UBS.

The rate of payment for order flow varies from broker to broker, but is usually fixed within the broker. A broker may charge 10 cents per 100 shares, for example. Others may charge more, some nothing.

Many discount brokers and commission-free investment apps utilize PFOF (see below for details) to earn additional compensation, but it doesn’t affect your investment choices or account safety. If you’re an active trader or day trader who regularly invests in options, PFOF might impact the final costs of your trades since the third-party firms do have some control over the speed of your order’s execution.

HFT firms who front-run your trades through PFOF arrangement

Retail investors are moving markets because your brokers sells its order flow to high-frequency trading firms who “front-run” the trades and increase momentum.

The practice, said to be pioneered by Bernie Madoff, is something used by Fidelity, Robinhood,  e*Trade,  Charles Schwab, and TD Ameritrade, among others, SEC Rule 606 disclosures show.

In the fourth quarter of 2020 alone, for instance, Robinhood, Schwab, E*TRADE, TD Ameritrade Holding Corp. and Fidelity Investments netted more than $750 million from payment for order flow, according to an S&P Global Market Intelligence analysis of quarterly filings. Not every retail brokerage accepts payment for order flow, though. Fidelity does not for any of the equity orders it sends to wholesalers. And one brokerage, New York-based Public Holdings Inc., said it is stopping the practice after the GameStop episode to “remove this conflict of interest” from its business model. Public will instead allow its customers to tip the company an amount they choose, according to a Feb. 1 blog post on its website.

According to investor.gov, the SEC’s consumer-advice site, brokers not only have the option to direct orders to HFT firms, but they can also utilize the following order execution options:

  • – If your stock trades in an over-the-counter (OTC) market, the brokerage can sell the order to an OTC market maker firm that executes your order
  • – Brokers can also route orders to electronic communications networks (ECNs) that can match buy or sell orders at certain prices
  • – Your broker may execute trades through a process known as internalization. This allows your investment app to send your order to another division of its company for execution. The firm profits due to the difference between what they paid for the security and what they’re selling it to you for

Citadel Securities gets almost as much trading volume as Nasdaq

In the US stock market, many of the most important places for matching buyers and sellers are now large trading firms. Taken together, two of the mightiest—Citadel Securities and Virtu Financial—account for more of the overall equity market than the New York Stock Exchange.

Trading companies and stock exchanges are obviously different types of businesses, but the comparison illustrates how retail brokerage has influenced US market structure in recent years. Apps like Robinhood and Schwab typically send their retail orders to companies like Citadel Securities, Virtu, or G1 Execution to execute the transactions. The firms, in turn, match buyers and sellers internally instead of on a traditional exchange like NYSE or Nasdaq. And retail buying and selling is soaring: For the largest online brokers, the number of daily trades has tripled since 2019, according to Goldman Sachs.

Citadel Securities handled 27% of all daily trades last year, generating $6.7 billion of revenue. The separate hedge fund business oversaw $34 billion at the start of 2021. On Citadel Securities company website, it states the firm executes 47% US-listed retail volume, making it the top wholesale market-maker.

Citadel says its hedge fund is kept separate from the securities operation. While the latter does trade for its own accounts, it is legally barred from doing so ahead of the orders it receives.

With Capitol Hill awakening to Citadel’s power, the firm may have much to lose if the government gets serious about overhauling rules that underpin the U.S. stock market.

What lawmakers learned so far has triggered demands for investigations into potential conflicts of interest and fueled conspiracy theories that Citadel teamed up with online brokerage Robinhood Markets to harm retail investors.

Robinhood CEO defends HFT is to benefit everyday investors?!

Citadel owns Robinhood. Citadel Securities — which is separate from Citadel but also founded by billionaire Kenneth Griffin, who’s its principal shareholder — executes Robinhood’s trades and capitalizes on razor thin price changes between the time an order is placed and when it settles.

Robinhood not only engages in selling customer orders but seems to be making far more than their competitors from it. Among brokers that receive payment for order flow, it’s typically a small percentage of their revenue but a big chunk of change nonetheless. Robinhood appears to be operating differently (see the data disclosed by zerohedge).

In December, Robinhood agreed to pay $65 million to settle allegations that it did not properly inform customers that it sold their stock orders to high-frequency traders. Robinhood neither admitted nor denied the claims.

Tenev and Robinhood co-founder Baiju Bhatt are no strangers to the world of high-speed trading. Before creating Robinhood, they ran Celeris, a hedge fund that used high-frequency trading strategies, and Chronos Research, a software firm that catered to algorithmic traders.

“Robinhood owes its customers a lot more than an apology because it has harmed their interests,” the New York Democrat and progressive icon said by video at Thursday’s House Financial Services Committee hearing on wild market swings in shares of GameStop Corp. and other stocks.