It's quite frustrating since I actually work for an HFT firm and the amount of misinformation about it in this comment thread is absolutely overwhelming. I don't even know where to start to debunk so many of the claims being made about front-running, or how paying for order flow works... all I can say is that reading through these comments really reinforces the point that plenty of people without any experience or background in a topic will talk about it as if they are experts in that field and there's no way to know who is and isn't knowledgeable on certain technically sophisticated topics.
Basically, take a topic that you're an expert in, find a discussion about that topic on the Internet and see just how much misinformation there is out there about it. Now consider all the topics you're not an expert in but read about on Internet discussion forums and you have to conclude that most of what people say is basically conjecture, speculation, and rumors with no sensible way to discern who is who.
It's kind of depressing.
Additionally why is it that they get a better rate than most retail brokerage houses with much more volume?
I don't know a lot about trading US equities, but this sounds wrong. Brokers are required by law to give their customers the best price ($99.99 in your example).
(1) The exchange is the middle man. The market maker is your counterparty, i.e. the person you actually trade with. The exchange facilitates the trades (often, not always - e.g. you might also trade off exchange, e.g. in dark pools (but you wouldn't do that unless you thought you were getting better prices) or by trading directly with market makers - in which case the US law protects retail customers from being "scammed") and also does clearing which means that it "guarantees" the trades - but that might not really work because an exchange cannot print money and so can go bankrupt itself - recent example in Norway:
https://www.bloomberg.com/news/articles/2018-09-14/nordic-po...
> The loss for Nasdaq’s default fund, that helps guarantee trades, amounts to 107 million euros ($125 million) and the exchange has issued a “replenishment contribution request” to cover the default losses. Current trading members will have to contribute in relation to their size and this is the kind of event the default fund was designed to handle, a company spokesman said.
(2) If you really want to call market-making "arbitrage", sure, go ahead - but it's time arbitrage, not price arbitrage. Similar to how your bank is (or was) doing time arbitrage by connecting short-term deposits with long-term loans (and earning a fee in the process). Without market makers, if you wanted to sell 1 share of AAPL (Apple), you'd have to wait until someone came along wanting to buy 1 share, and then you'd have to agree on a price. Market-makers facilitate trading by continuously providing bid-ask quotes, so that you can sell immediately at a known price, and then 1 hour later someone can buy immediately at a known price (minus the "fee" (spread) that marker makers earn).
All in all, I don't think you even need to use brokers. You can just find buyers yourself and sell directly to them, avoiding the "evil arbitraging market makers" in the process.
Correct. And Robinhood is a broker, so it is also required to.
> Robinhood doesn’t submit orders directly to exchanges
Correct, but irrelevent.
> it always passes through a middle man
Correct.
> who has to collect some fee for their service.
Incorrect. They are not charging Robinhood (or their customers) a fee.
Robinhood's clients get the NBBO, as required by law, full stop. There's no trick here.
If you are curious where the average broker routes orders to, they all file Rule 606 documents with the SEC.
Here is Robinhoods for Q1 2019: https://d2ue93q3u507c2.cloudfront.net/assets/robinhood/legal...
These filings show exactly how much each HFT, aka market maker, got routed by robinhood.
Here is Schwabs: https://www.schwab.com/public/schwab/nn/legal_compliance/imp...
What you will notice is that both have roughly similar distribution across execution venues, and the same can be said about many retail brokerage firms (Fidelity, Etrade, and the like). The difference is that Robinhood makes quite a bit more money from Payment for Order Flow than the typical brokerage.
Back in 2016 when Robinhood was gaining traction, I was pretty suspicious that they were either directly front-running their own users, or they were selling order flow to HFT's. Back in that day, both of the founders still had a LinkedIn that showed that they both worked at an HFT! before starting Robinhood. Since then they have removed that history from their profiles, but it's definitely not a good look if you are saying you are commission free! Selling order flow is the norm in the industry, but there is certainly a special relationship between Robinhood and their execution venues that isn't completely clear.
Overall, I am in the boat that Robinhood should at least be required to say that they aren't perfectly commission free. It seems that the commission most users pay is just indirectly being paid to an HFT, then kicked back to Robinhood.
With all of that being said, unless you are making huge block (100's of shares) trades, it's probably still cheaper to use Robinhood than a retail firm.
My hypothesis is that Robinhood gets higher kick backs because:
1) The user base is typically not financially savvy.
2) Users are more likely to do "market" orders leading to more profit for HFT's
3) Since there is no commission fee, users feel like they can buy or sell with 0 friction meaning the average user will end up in and out of positions much more frequently.
All of those things mean more profit margins for HFT's to kick back to Robinhood.
Robinhood certainly is "free", but the issue is that without friction, e.g. $10 trade fee, you as an investor will hop in and out of positions quickly, meaning more profit for the HFT, and indirectly, Robinhood. However, for most of us Robinhood is still cheaper than a brokerage even with this hidden tax.
I recommend avoiding options, penny stocks, and cheap-per-share stocks if you want to avoid paying a higher hidden tax to HFT's.