
Robinhood Gets Almost Half Its Revenue from Bargain with High-Speed Traders - theslurmmustflo
https://www.bloomberg.com/news/articles/2018-10-15/robinhood-gets-almost-half-its-revenue-in-controversial-bargain-with-high-speed-traders?srnd=premium
======
dang
[https://news.ycombinator.com/item?id=17956740](https://news.ycombinator.com/item?id=17956740)

[https://news.ycombinator.com/item?id=17998846](https://news.ycombinator.com/item?id=17998846)

------
tptacek
Isn't this the entire idea behind Robinhood? Obviously, they make money
elsewhere (from interests on deposits?) but hasn't it been clear for years
that they were getting paid by internalizers for order flow?

Whoever you use to place stock market orders is also getting paid the same
way. People have a funny idea of what a retail brokerage does. They do not
execute orders on exchanges for you; that's a specialized capability that long
ago became its own kind of company. Retail brokerages specialize in picking up
the phone when you call with a complaint or request, and in advertising to
acquire users.

You shouldn't care. The reason your order flow is valuable isn't that Citadel
is trying to screw you. Rather, they can (occasionally) quote you better
prices than they do the market as a whole, because they know you're not a
giant investment bank or hedge fund about to roll over them like a freight
train with a giant block order that will demolish every level of the order
book. Internalizers can essentially arbitrage the difference. They're required
by law to meet or improve the NBBO.

~~~
jakarta
Interactive Brokers does not sell your order flow

~~~
jbeyer
Yea....Timber Hill is owned by Thomas Petterffy, founder of Interactive
Brokers, and handles much of the options order flow from IB users. So...IB may
not be making money off those trades, but the founder is still profiting from
them. Don't get me wrong, as someone who has followed market structure for
years, I don't think that IB is doing anything worse than anyone else, but
they aren't innocent in this regard.

~~~
physguy1123
Timber Hill did not participate in the retail business to avoid conflict of
interests with IB.

For what it's worth, one can't internalize options orders in the same way one
can equity orders, purchased options flow must make it to the market. I'm not
familiar with the history of this decision but I suspect it's since options
are less liquid and have higher spreads, so internalization would get a much
worse deal than say auctions. You can rebates from certain exchanges for
initiating auctions on them, and can selectively initiate auctions on
exchanges which benefit you more, but options orders themselves make it to the
market

~~~
jbeyer
Quite regularly, I see that my orders are filled at Timber Hill, when there
are other participants offering at the same price. We may be quibbling over
the definition of "internalization", but that is internalization.

~~~
physguy1123
It is strictly not internalization, in fact, and as far as I know from friends
working on retail at the new owner of Timber Hill IB and Timber Hill didn't
ever cooperate on optimal routing strategies since Thomas Pterfry didn't want
people loosing faith in IB routing. There are plenty of reasons why Timber
Hill might win the trade:

    
    
      * They might be first in the queue on a price-time exchange, and so naturally get the order
    
      * They might be on a price-size exchange, and so get some of the fill simply by being present.
    
      * They probably participate in the auction process, and will naturally get some portion of orders that IB initiates
    

For what it's worth, Timber Hill USA was bought by Two Sigma ~1 year ago. It
wasn't actually unprofitable as shown by public filings, but wasn't making
much and Thomas Pterfry didn't want an illusion of conflict of interest.

~~~
jbeyer
What you say about them "winning" the trade is not accurate. If it were
happening on an exchange, as in each of your three examples, the trade would
show as being on that exchange, and I wouldn't know who the counterparty was.
If the exchange is "Timber Hill", then IB chose to route the order there,
which is internalization.

~~~
physguy1123
If you're talking about the USA, this is incorrect. I actually work in the
industry and know how this works

* One has to initiate an auction of the client order, at least in the USA - see [https://www.sec.gov/rules/concept/34-49175.htm#P193_52817](https://www.sec.gov/rules/concept/34-49175.htm#P193_52817), specifically "Unlike internalization in the over-the-counter equity market, the options exchanges' rules permit a firm to trade with its own customer's order only after an auction in which other members of that market have an opportunity to participate in the trade at the proposed price or an improved price. This auction provides some assurance that the customer's order is executed at the best price any member in that market is willing to offer". In practice the placing firm will bid for the auction at that price, and non-competitive prices don't get posted since then the firm has to lose money.

* counterparty data is reported by the OCC so regardless of where the order was executed you will know who was the counterparty. It's fairly easy for IB to know whether Timber Hill executed an order, whether or not they intentionally routed it there.

Second, I actually have inside knowledge of a sort about how Timber Hill USA
worked before getting purchased by Two Sigma, and they did not work with IB to
take customer orders and weren't to happy when they did get customer orders
that originated from IB, specifically because people then run around
complaining that IB is up to spooky business internalizing with Timber Hill.

------
vasilipupkin
this article is extremely misleading, creating what essentially is a fake
controversy. I highly recommend reading this SEC guide to understand how it
really works.

[https://www.sec.gov/reportspubs/investor-
publications/invest...](https://www.sec.gov/reportspubs/investor-
publications/investorpubstradexechtm.html)

------
httpz
So other brokers charge you and sell your trade data and Robinhood just sell
your trade data? I'll just stick with Robinhood then..

------
anonu
This is called pfof. Pay for order flow. It's very common practice to sell
retail flow or exhaust flow to the likes of citadel and a dozen others.

The buyers make money by either taking the spread on an order, reducing risk
in their own portfolio or using the order to create impact and internalizing
the tail.

~~~
dawhizkid
According to this analysis
[https://seekingalpha.com/article/4205379-robinhood-making-
mi...](https://seekingalpha.com/article/4205379-robinhood-making-millions-
selling-millennial-customers-high-frequency-traders?page=3) HFTs pay Robinhood
significantly more for their order flow than other brokerage firms i.e.
claiming almost 12x more than E-Trade makes ($260 per $1m in orders vs $22 per
$1m). If this is true (I haven't independently verified but these fees must be
published publicly by law), then clearly HFTs are getting _something_ more
from RH than they are from other brokerages.

The author goes on to say "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."

~~~
anonu
I read that analysis when it came out. I'm not sure how accurate it is... in
the end Robinhood still needs to make money since they aren't charging the
typical per trade commissions.

You can probably back out what the HFTs margin is on this stuff by looking at
public financials... KCG was public for a while.

~~~
dawhizkid
Why would HFTs pay so much more for order flow from Robinhood vs other online
brokerages?

~~~
tptacek
Because individual retail traders are (a) generally uninformed and (b)
relative to institutions, have very small positions they want to move in the
market. Those orders are intrinsically more valuable, because they aren't
risky to make markets for.

Essentially, your trades have a lower cost basis than those of institutions.
But the markets are generally priced assuming institutional traders. So if
firms know you're not an exchange they can save some money on you, and
Robinhood _literally_ passes some of those savings to you.

(I don't love Robinhood or anything, but the model makes perfect sense.)

------
gammateam
As someone that paid $25,000 in options commissions in 2015 even after
negotiating down to 50 cents/contract and no ticket charge, free options
trading in exchange for my trade data is a fair trade

Now if only they'd give the option of Portfolio Margining instead of just
Reg-T margining, I'd let the HFT's pair-program with me in person.

~~~
anonu
It's never free. You're always paying somewhere. If not explicitly, you're
paying via spreads or rich options valuations when you're buying...

~~~
tptacek
Exactly how do you think you're paying it here? Be specific.

 _Later: to be clear, my subtext is that Robinhood customers aren 't actually
paying anything and are sort of getting a free lunch here. The money Robinhood
pockets from your trades isn't available to you in any form, at least until
someone starts the brokerage that pays you to trade._

~~~
anonu
Typical internalizer trade is:

1\. RH user wants to buy 1000 shares of XYZ. Offer price is $10.00

2\. RH forwards the full order to their execution venue partner. They get paid
(assuming SeekingAlpha story is true) $260/$1mm traded, or $2.60.

3\. Executor takes the order and immediately sends 900 shares to the market,
lifting the offers. Now best offer is $10.10

4\. Executor facilitates the tail of the order, 100 shares, at $10.10. So they
are short -100 shares here - or they can give a de minimis price improvement
(like 10.0985) to meet their contractual obligations.

5\. Temporary market impact attenuates and offer mean reverts to $10.05

6\. Executor still has risk on their books - but their paper mark-to-market
profit is $5.00.

7\. Risk can be mitigated by waiting for crossing order or waiting for more
favorable offers to close out the short.

So roughly speaking they paid $2.60 to get the order, but made $5 on it...

~~~
tptacek
That's how you're saying the internalizer made money on it. Obviously, they
make money on the order flow. The question is how they cost _you_ anything.
What could you have done differently to capture the $2.40 in hypothetical
profits here?

~~~
anonu
So, first off, I am not saying internalizers are all evil and that pfof is
bad. That $2.40 your retail trade earned the internalizer is the price you pay
for convenience and immediacy. You let someone else handle the order and they
do what they want with it - within certain guidelines.

You could have saved the hypothetical $2.40 had you traded differently, albeit
slower, and caused less market impact with your order. Of course, trading
slower comes with its own slippage risk or opportunity cost that the market
moves out of your favor. But it could also move in your favor... However, if
you let a greedy HFT use your order to impact the market - it will always be
out of your favor.

For a small retail guy, you are powerless unless there is a RobinHood 2.0 that
decides to offer comm-free trades + does not sell your orders + makes money
doing something else ... stock loan maybe?

EDIT: Also the HFTs hate limit orders because it reduces the amount they can
internalize. They also generally have a contractual obligation to always
execute your order. So you can always use a limit at or inside the offer if
youre buying, and potentially save on that cost.

~~~
tptacek
I don't understand the outline of your argument. If what you're saying is
true, then you can _non-hypothetically_ save that $2.40 by... trading slower
and with less impact on the market.

This is why I asked for specificity. Yes, we agree, internalizers pay for
order flow because they can make money on it. The question is: can _you_ make
that money on your own order flow, or is the allocation of orders to
internalizers Pareto-optimal?

~~~
anonu
Internalizers want the entire order. If RH splits a order across multiple
internalizers they will not be happy. So RH allocates in a Pareto-optimal way.
As the order creator, you cannot earn that $2.40, you can only save by getting
a better price.

~~~
tptacek
Upthread, you said "It's never free. You're always paying somewhere." But it
turns out to be pretty hard to even describe how Robinhood customers are
"paying" for their order routing.

------
m0j0e
As usual, Matt Levine provides great comments on this:
[https://www.bloomberg.com/amp/view/articles/2018-10-16/carl-...](https://www.bloomberg.com/amp/view/articles/2018-10-16/carl-
icahn-wants-to-fight-dell-again) (second section)

------
swampthing
At the beginning of the article, the authors cite 3 anonymous sources:

> ... according to three people with knowledge of the matter, who asked not to
> be identified because the details are private...

Then, the end of the article mentions 3 VCs:

> Two venture capitalists, speaking on condition of anonymity because the
> discussions were private, expressed concern that Robinhood's ties to high-
> frequency traders might undermine its image and stymie expansion plans. A
> third said it was the reason he didn't invest.

I wonder if this article is the product of some VC sour grapes.

------
thejgr
Check out Robinhood’s Co-Founder’s blog post here
[http://blog.robinhood.com/news/2018/10/12/a-letter-from-
robi...](http://blog.robinhood.com/news/2018/10/12/a-letter-from-robinhood-co-
founder-amp-co-ceo-vlad-tenev)

------
wgerard
I was under the impression that retail order flow is mostly useless to HFT and
they make money on large institutional moves - retail investors just don't
affect the market enough for it to matter.

Is that a wrong assumption? If not, seems like maybe RH is just taking
advantage of the rebate for not much benefit to Citadel?

~~~
JumpCrisscross
> _retail order flow is mostly useless to HFT and they make money on large
> institutional moves_

This is incorrect. Retail volumes are smaller. (This also makes them less
risky to fill and offload.) But spreads are wider.

I worked on an algorithmic derivatives desk many years ago. We paid a well-
known national broker _lots of money_ to get their options flow. Their
customers were notorious for forgetting to exercise slightly in-the-money
options, putting in misplaced limit orders, putting in market orders for
illiquid names, _et cetera_.

Robinhood has its hands on the money of a generation that was too young to
lose money in the last crisis.

~~~
adrr
Don't most brokerages exercise ITM options at expiration? Here is Etrade's
policy:

> Equity options $0.01 or more in the money will be automatically exercised
> for you unless you instruct us not to exercise them.

------
pg_bot
Hmm, I'm assuming this is illegal (otherwise someone would likely be doing it)
but why doesn't a high frequency trading firm make a competing application and
just keep that order flow for themselves? Why not vertically integrate?

~~~
kasey_junk
Because retail sucks & their core competencies have nothing to do with dealing
with customers.

~~~
tptacek
Seriously you'd think on a board ostensibly obsessed with CAC and ARPU
metrics, it would be immediately obvious why a specialty player wouldn't want
to compete with Schwab and Fidelity.

~~~
pg_bot
Multiple players along the chain could decide to vertically integrate.
Although I used the example of high frequency traders, a better question which
I should have asked is why hasn't _someone_ dipped their toes into retail and
HFT? It seems like someone would want to grab that land for themselves if it
were particularly valuable, which the valuation of Robinhood purports.
Considering some guys in that industry made this app, I don't think it's _too_
far a stretch of the imagination for someone to believe that an industry
player could have made that move.

~~~
physguy1123
If you're an HFT, you would much rather just pay for the order flow and not
deal with all the shit that is retail (government, customers, all that shit).
If you're some big retail firm, you're probably run by suits, way to
beauracratic to run a difficult high-tech trading team, and any talent you got
would get siphoned off to a good trading firm.

~~~
vasilipupkin
different competencies. Acquiring retail customers is very hard and is not
something HFT firms have any special competency in.

------
krn
Freetrade[1] is a crowdfunded European alternative to Robinhood.

[1] [https://freetrade.io/](https://freetrade.io/)

~~~
tptacek
Does Freetrade say somewhere that they don't pay for execution services from
some other company? If they don't, is that a _good_ thing? Doesn't that imply
that they think they can outcompete Citadel and Two Sigma on execution?
Because, like, they can't? Right?

~~~
krn
> A year in the making, Freetrade has built a bona-fide “challenger broker,”
> including obtaining the required license from the FCA (the U.K. regulator),
> rather than simply partnering with an established broker as it is understood
> Revolut initially plans to do. This, Dodds explained on a call, has enabled
> the startup to plug directly into the capital markets “piping,” with as few
> intermediaries as possible. It means Freetrade can execute trades on its own
> behalf and ultimately be much more in control of its own destiny. It should
> also help the startup maintain a lower cost-base as the app scales.

[https://techcrunch.com/2018/10/02/freetrade/](https://techcrunch.com/2018/10/02/freetrade/)

~~~
tptacek
I saw that, but that just says they have (in some circumstances) the option to
place their orders. I'm unclear why that would necessarily be a good thing,
but either way: have they made a clear statement that they're not farming
retail orders out to other firms? If they are, they're going to get paid for
them.

~~~
krn
Their entire business model seems to be extremely transparent[1], and they
treat their users as customers, not products. I don't know what they are doing
now, but I think that farming retail orders out is not something they would be
focused on in the long run. It's more like "mobile-first Interactive Brokers
for equity trading".

[1] [https://freetrade.io/pricing/](https://freetrade.io/pricing/)

~~~
kasey_junk
If you read their order-execution statement they are _very clearly_ doing
things that are going to have bad execution.

Their 'default' order price is a market order that they promise will _not_
clear until after hours or the next day.

[https://freetrade.io/order-execution/](https://freetrade.io/order-execution/)

This is quite possibly the worst way a retail investor could send in an order.

~~~
krn
> Their 'default' order price is a market order that they promise will not
> clear until after hours or the next day.

Isn't this only true for the non-paying users, who are not subscribers of
their premium plan? That's probably their entire (freemium) business model.
It's the same with Revolut: free users might lose more money in foreign
exchange and withdrawal fees, which pushes them to upgrade[1].

[1] [https://www.revolut.com/pricing](https://www.revolut.com/pricing)

~~~
tptacek
Even if you pay them $10/mo (whether you trade or don't, and keeping in mind
that most people shouldn't be trading most months!), they still charge you for
"instant" orders (the kind they don't delay purposely) in the one market they
actually execute orders in.

Robinhood seems like a better deal.

~~~
krn
That's a good point. It's hard to compare a crowdfunded company with a one
burning through more than 500 mln USD in VC funding. But I see no reason why
people shouldn't be increasing their passive portfolios every month if they
can. And with many brokers, $10 is around a minimum commission for a single
trade.

~~~
tptacek
We are commenting on a thread about a brokerage with substantially lower fees
than that.

------
ForHackernews
Dumb money for sale.

~~~
kasey_junk
This is true, but it uses an unfortunate industry term that is more pejorative
sounding than it actually is.

When people in the industry talk about 'dumb money' they aren't talking about
how informed or intelligent the order flow is. They are talking about how
likely the order relates to market structure.

An individual investor who has looked at their portfolio and decided that the
best move for their investment horizon is to move a big component out of
equities and into bonds is still 'dumb money'. Even though that might be the
most intelligent option.

A bot that has a _terribly performing_ algorithm that takes market structure
into account is _not_ dumb money though.

~~~
394549
> They are talking about how likely the order relates to market structure.

What do you mean by "market structure?"

~~~
kasey_junk
When people talk about 'the stock market' or 'the stock price' they are using
a very coarse abstraction.

In reality for most trade-able instruments there are a variety of exchanges
all operating at once. Further in each exchange there isn't a single price.
There is a collection of buy and sell orders that combined together form the
'book'. For instance if you had 10 buy orders at $1 and 2000 sell orders at
$1.10 what is the 'price' of that thing? The structure of the book and how all
the exchanges relate (and Reg NMS in the US equities space) are all the
'market structure'.

------
jhabdas
Robinhood locked me out of my own account because I was "traveling too long";
demanded I show them proof of US residence (my verified Chase Bank account and
US passport aren't good enough). I'm not surprised they're hurting the little
guy.

------
api
Once again: if the product is free it usually means you are the product.

------
nodesocket
ProTip: use LIMIT/STOP orders when buying and selling. Sending MARKET orders
to Robinhood guarantees you going to get a "worse" price compared to the spot
price.

~~~
colinbartlett
Does this apply to an ordinary low-level retirement investor like me? If I am
buying, let's say $500 a week, in some fund as part of my IRA, what does a
LIMIT/STOP order do for me? I'm buying it no matter what, the share price is
meaningless to me, I will just get more or less shares.

~~~
nodesocket
> what does a LIMIT/STOP order do for me?

For example buying a LIMIT says the highest price I am willing to pay per
share is X. So you can be confident you'll get a price at least equal to or
below the limit price.

> the share price is meaningless to me

??? Confused. Do you like buying high and selling low?

~~~
physguy1123
The downside of setting a limit order is that you only get executed when the
market moves against you, OR just don't get filled.

For retail order sizes and holding periods, that's probably fine as long as
you place orders close to the current price.

~~~
cinquemb
There is also the case when no one else wants to sell (buy) and bids (asks)
way out number asks (bids), especially on contracts that people are using to
cover for their other trades. There's plenty of times where I massaged the
price up (or down) to where I wanted it more, and dumped/slurped up contracts
(at least confirming by checking the bar once it filled and seeing that the
price I got filled at was the highest/lowest price of that bar). Granted, it
doesn't happen every time, nor do I count on it.

------
pazimzadeh
I'm not sure I completely understand this article, but I'd like to take this
opportunity to rant about my recent experience using Robinhood. Two weeks ago
I noticed that Tesla stock dropped significantly after the SEC's investigation
into Elon Musk's "funding secured" tweet led to Elon being ousted as chairman
of the board. I thought the stock would recover from this, so I placed a
market price order for TSLA shares on Sunday night (September 30th). Indeed,
on Monday the stock rose +17% but lo and behold, my order never went through.
The reason given was that the stock price had supposedly changed by at least
5% by the time the market opened. I suspect this is because Robinhood
prioritizes orders from high speed trading firms over its own customers. Is
this common practice, and can anyone recommend a service that doesn't do this?
Thanks in advance.

~~~
thebird
It was obvious to many people that the stock price would rebound significantly
after Musk settled with the SEC, so the stock had already effectively
increased in price before market open. Robinhood couldn't find anyone willing
to sell you shares at the market close price Monday morning because there were
none to be had.

~~~
pazimzadeh
The settlement news came out earlier - Friday’s news was Musk’s punishment,
which was light. But thanks for the reminder that stock prices are not numbers
on an app, in my rage/greed I forgot how markets operate.

