As the twin black swans of the coronavirus pandemic and the historic collapse in oil prices rocked financial markets in early 2020, opportunities arose.
So did the media narratives.
One of the most popular: Bored youths, trapped at home with no access to sports, bars, or live entertainment, went into daily business, in many cases with an online brokerage that seems tailor-made for the Gen-Y set. : Robin Hood.
While there is plenty of evidence that a handful of millennials engage in day-to-day business and, in some cases, lose a lot of money, with sad and shocking results, their numbers and any impact they may have on the market is less certain.
What’s more, for anyone who has spent a career observing and helping to fine-tune the infrastructure behind trading in the financial market, part of the discussion about what is really happening is not informed or helpful, according to one analyst.
“There is a narrative that Robinhood was doing something nefarious to make money from its clients in an illegal or unethical or out of the norm way,” said Dave Nadig, a veteran of exchange-traded funds, an industry that relies on – and has possibly helped to bring to maturity – the pipelines and pipes of the financial system. “Actually, it’s a storm in a kettle.”
Related:Retail investors are being ‘sleeves’ with the largest oil ETF with a drop of over 30% this week
The talk about how Robinhood and other brokerage houses make money reveals a deep misunderstanding about how trading occurs, Nadig told MarketWatch. Nadig wrote on his blog about order flow, in his capacity as chief investment officer and chief research officer for the ETF Database, but he also shared some insights in an attempt to clear things up and hopefully help the average investor understand what It happens when he or she does a trade.
Read:Here is the correct way to trade ETFs
Most investors think that when they try to sell a stock or ETF, the brokerage platform they use will find another interested investor to buy it, and vice versa.
In fact, all brokerage houses work with companies called market makers, whose job is to establish a link between everyone who wants transactions to take place: the buyer, the seller, and the brokers on both sides.
The term “market maker” and the various metaphors that are often used to describe them make his role seem very personal, almost tailored, Nadig thinks. In reality, such companies operate massive algorithm-based programs that allow them to see vast stretches of financial markets at once: who wants to buy, and at what price, who wants to sell and the price they want to get, and what’s more important, if the market maker can make some basic points about the difference.
“What we are talking about is an extraordinarily thin margin business,” Nadig said. “It happens millions of times per second.”
In fact, it is such a high volume that market makers pay brokers for the ability to broker transactions. That is known as “order flow,” and it is the process that caught the attention of social media.
“If you’re trading at Robinhood, just know that your order flow data is being sold to hedge funds so they can manage it,” wrote an anonymous Twitter user.
Nadig thinks that is wrong. Market makers should benefit a broker’s clients not only by facilitating trade, but also by allowing them to obtain better prices. In the same way that market makers use huge computer programs to determine which trades to perform, brokerage firms have their own rules-based programs, which route trades so that they can be carried out more efficiently.
Unfortunately, it is impossible to verify any brokerage’s claims of what the industry calls “price improvements,” says Nadig. It’s worth noting that Robinhood was fined $ 1.25 million in 2019 for settling a complaint from a regulator that it did not guarantee that its customers received the best price for transactions. Nadig thinks that is even more incentive for the company to follow the rules now.
However, there is some transparency in order flow: the Securities and Exchange Commission requires brokers to submit a quarterly “road report”. The latest from Robinhood is here.
Robinhood’s media relations department did not respond to MarketWatch’s specific requests for comment for this story, but referred readers to an online article on how it routes requests. Of the 2019 fine, a spokesperson said, by email: “The facts on which the agreement is based do not reflect our current practices or procedures. The agreement relates to a historical problem during the 2016-2017 period that involves consideration of alternative markets for order routing, internal written procedures, and the need for further review of certain types of orders. In the past two years, we have significantly improved our best execution execution monitoring tools and processes, and have established relationships with additional market makers. ”
Perhaps more important than order-specific logistics, Nadig thinks, is the underlying reality: Millions of people trade brokers like Robinhood (and Schwab, Interactive Brokers, TD Ameritrade, and many more) for free.
Brokerage firms have other sources of income, of course: margin loans, advisory arms, etc. But most of all, “Every broker is in the business of making transactions move through the system. They just want volume, ”said Nadig. Any lubrication that helps that movement is important, he said. Finally, “Robinhood is not there to teach you financial education or how to pay off your student loan. It is very good for you to make transactions. It’s Tinder but for money.
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