I'm not super interested in the whole GameStop fiasco, but a paragraph in a New York Times piece caught my attention last night. A lot of the trades that have sent GameStop into the stratosphere were made via Robinhood, a trading app that charges no fees. So how do they make money?
Without fees, Robinhood makes money by passing its customer trades along to bigger brokerage firms, like Citadel, who pay Robinhood for the chance to fulfill its customer stock orders.
Wait. Robinhood can't make money with $0 fees, but Citadel can apparently make money with essentially negative fees. I'm no high finance guy, but what am I missing here?
UPDATE: A reader answers my question:
There is value in the "flow" itself. Market makers (like Citadel or others) earn return by buying and selling particular stocks. If they have a ton of orders, buys and sells, at different prices, they can fill those orders in such a way as to earn a spread on each transaction (or really the totality of transactions as they are essentially wholesalers). This is how trading works. Commissions are just like a processing fee. That's not how trading desks make money.
Huh. Somehow this still seems like a good way to lose a ton of money if things go pear shaped. But my money is all in low-load mutual funds, so what do I know?
Citadel is not making just a little on these trades. Most shares vary by a 5-10 cents every few seconds, for a $50/share stock, i.e by 0.1%. So, for a market order, Citadel would have to try pretty hard to avoid making 0.2% of the order flow. Google tells me that daily market flow on NASDAQ is $100B, so 0.2% is $200M/day.
Limit orders are probably even worse, whether above or below market.
And this is probably a low estimate. And it is risk free as far as Citadel is concerned: they have both orders in hand at the same time, and they just have to figure out how badly to screw their customers.
Citadel is not making just a little on these trades. Most shares vary by a 5-10 cents every few seconds, for a $50/share stock, i.e by 0.1%. So, for a market order, Citadel would have to try pretty hard to avoid making 0.2% of the order flow. Google tells me that daily market flow on NASDAQ is $100B, so 0.2% is $200M/day.
Limit orders are probably even worse, whether above or below market.
And this is probably a low estimate. And it is risk free as far as Citadel is concerned: they have both orders in hand at the same time, and they just have to figure out how badly they want to screw their customers.
That’s why there’s are brokers yachts and no customers yachts. Brokers never risk their own money. They’re exactly like bookies.
They’re front running. They have orders on both sides and arbitrage the milliseconds of difference as to when each is executed.
Front running users to be illegal. Then certain Wall Streeters got to the point where they could front run in the sub-millisecond range. I don’t know why, but suddenly that was okay.
"Somehow this still seems like a good way to lose a ton of money if things go pear shaped. "
Indeed it does.
Allow me to introduce you to 2008.
As we’re seeing, the way things played out after 2008 is the problem. The buyers are on one sided of the short-squeeze and they stand to win or lose potentially serious amounts of money. Normally, being caught in that sort of a trap would be like shooting fish in a barrel for the people who are long on that stock.
But, as we saw in 2008, hedge funds and banks are gambling with the taxpayers money and the game is rigged do that the can’t lose. I’ve very little doubt that the shorts (who are probably highly leveraged )would normally be buffeted by constant margin calls and an ever escalating stock price as the nature of the hedge funds predicament becomes more exposed. Instead, Wall Street and the government are actually supposed the hedge funds and seem to be ready to force the longs to eat huge and unfair losses.