WEBVTT - How They’re Really Making Money On Your Free Robinhood Trades 0:00:11.119 --> 0:00:14.600 Hello, and welcome to another episode of the Odd Lots podcast. 0:00:14.640 --> 0:00:17.960 I'm Joe Wisn't Thal and I'm Tracy. Tracy. I have 0:00:18.040 --> 0:00:22.680 a question about things in Hong Kong, which is, are 0:00:22.720 --> 0:00:25.079 people going crazy for stock trading there the way they 0:00:25.120 --> 0:00:28.720 are here? It's a good question. I'm not sure if 0:00:28.760 --> 0:00:31.720 this is reflected in Hong Kong, but definitely in mainland 0:00:31.840 --> 0:00:36.760 China We've had this massive rally in Chinese shares, So yeah, 0:00:37.000 --> 0:00:39.440 over there we're having like a similar retail boom to 0:00:39.560 --> 0:00:42.360 what we have seen in the US. Yeah, I mean 0:00:42.400 --> 0:00:44.159 it's pretty crazy. I mean that has been you know, 0:00:44.200 --> 0:00:47.600 there's a lot of like subplots to this crisis. In fact, 0:00:47.640 --> 0:00:50.920 that's sort of the theme of our podcast over the 0:00:50.960 --> 0:00:53.720 last several months, is just exploring all of the subplots. 0:00:53.760 --> 0:00:58.360 But the the incredible boom that we've seen in retail 0:00:58.440 --> 0:01:01.920 trading activity has to be one of the more surprising ones. 0:01:01.960 --> 0:01:03.520 And of course the whole you know, it's the whole 0:01:03.600 --> 0:01:06.880 robin hood phenomenon. All these people their home, they're not 0:01:07.400 --> 0:01:10.600 their jobs, there's no sports betting going on, and so 0:01:10.680 --> 0:01:12.559 it's like, all right, well I got a few bucks 0:01:12.600 --> 0:01:15.959 laying around, maybe I'll bet on some Tesla shares for 0:01:16.040 --> 0:01:19.200 free on robin Hood. Yeah. I think that's it, isn't it. 0:01:19.200 --> 0:01:22.319 It's it's not it's not necessarily that retail investors are 0:01:22.400 --> 0:01:25.199 jumping into the stock market. It's the way in which 0:01:25.240 --> 0:01:28.600 they're doing that. Because we have commission free trading now, 0:01:29.040 --> 0:01:31.319 you can kind of take a punt on a bunch 0:01:31.360 --> 0:01:36.560 of stuff without necessarily losing that much money, at least upfront, 0:01:36.920 --> 0:01:39.520 I guess. And like the punts that we are seeing. 0:01:40.120 --> 0:01:45.640 Tesla hurts switched to Clared bankruptcy. Everyone's been talking about those, 0:01:45.680 --> 0:01:50.240 and I think that really that really stands out right now. Yeah. Absolutely. 0:01:50.520 --> 0:01:53.000 I remember like last year, I think it was it 0:01:53.040 --> 0:01:55.960 was last year and Charles Schwab announced that who was 0:01:55.960 --> 0:01:59.200 going to cut commissions to zero, and a bunch of 0:01:59.200 --> 0:02:02.720 other online broker bridges followed suit, and my first though 0:02:02.800 --> 0:02:04.400 was like, oh boy, like, people are gonna lose a 0:02:04.400 --> 0:02:06.880 ton of money because they're gonna overtrade, and some people 0:02:06.960 --> 0:02:09.320 probably are. But the weird thing is that a bunch 0:02:09.360 --> 0:02:12.000 of people who jumped into the market over the last 0:02:12.040 --> 0:02:15.000 several months have actually participated in one of the most 0:02:15.000 --> 0:02:18.359 extraordinary rallies we've seen of all time. So for now, 0:02:18.520 --> 0:02:21.240 some people are clearly winning. Yeah, But the other part 0:02:21.280 --> 0:02:25.400 of the story is, I guess the downsides of retail participation, 0:02:25.520 --> 0:02:28.080 or not the downsides, but the criticism that comes along 0:02:28.120 --> 0:02:31.160 with it. So obviously a lot of people have been 0:02:31.600 --> 0:02:34.920 making fun of people who are buying Tesla stock or 0:02:35.280 --> 0:02:39.520 bankrupt company stock. We've also had some criticism of some 0:02:39.600 --> 0:02:44.440 of the trading platforms, but particularly robin Hood, which seems 0:02:44.440 --> 0:02:49.480 to be at the at the forefront of commission free trading. Right, 0:02:49.600 --> 0:02:52.520 robin Hood has sort of become it's kind of like 0:02:52.600 --> 0:02:55.680 become like the like band aid or Kleenex. It's like 0:02:55.680 --> 0:02:59.359 this brand, but it also is synonymous with a phenomenon 0:02:59.440 --> 0:03:01.320 or an industry, you where lots of people are getting 0:03:01.639 --> 0:03:06.760 into trading and this whole commission free retail craze it also, 0:03:07.240 --> 0:03:10.760 um you know, raises some questions in addition to just 0:03:10.760 --> 0:03:13.480 sort of the retail side, about how the industry is 0:03:13.560 --> 0:03:17.040 making money and who is really the big winner here, 0:03:17.040 --> 0:03:19.680 Because sure, there are some people that have probably turned 0:03:19.680 --> 0:03:22.760 a little bit of money into um, you know, millions 0:03:22.840 --> 0:03:27.320 thanks to investing in buying call options on Tesla, but 0:03:27.520 --> 0:03:29.720 also a lot of people are just are making a 0:03:29.760 --> 0:03:33.720 lot of money just handling this incredible order flow, this 0:03:33.880 --> 0:03:37.440 incredible activity. And obviously with commissions having gone to zero, 0:03:37.560 --> 0:03:40.760 the business model has changed a little bit safe from 0:03:41.040 --> 0:03:43.960 the late nineties when the online brokers say like charged 0:03:44.040 --> 0:03:47.000 just fourteen dollars a trade or whatever it was, right, 0:03:47.120 --> 0:03:50.040 so there's no free lunch and economics, there's supposed to 0:03:50.040 --> 0:03:52.520 be no free lunch when it comes to trading. But 0:03:52.680 --> 0:03:56.960 clearly retail investors are getting you know, commission free trades, 0:03:57.400 --> 0:03:59.800 and yet someone must be making money off of those. 0:04:00.200 --> 0:04:02.680 How are they doing it? Exactly? And again that kind 0:04:02.680 --> 0:04:05.560 of feeds into some of the criticism that we've seen 0:04:05.600 --> 0:04:08.800 around the robin Hood platform. Yeah, exactly right. So that's 0:04:08.800 --> 0:04:11.520 what we're going to dive into today, like who's really 0:04:12.040 --> 0:04:15.840 making money off of all this activity? How sustainable it is, 0:04:16.640 --> 0:04:20.719 what the new business models of online brokerage really look like. 0:04:20.880 --> 0:04:24.919 And so we're going to be talking to a great guest. 0:04:24.960 --> 0:04:27.039 He's actually with us at Bloomberg. He's the head of 0:04:27.080 --> 0:04:32.520 market structure research at Bloomberg Intelligence. Larry tab is joining 0:04:32.600 --> 0:04:36.560 us to explain the sort of the new retail online 0:04:36.560 --> 0:04:39.800 broken landscape. Who's making money out Larry, Thank you very 0:04:39.880 --> 0:04:43.400 much for joining us, Joe and Tracy. I'm really happy 0:04:43.400 --> 0:04:45.599 to be here. It's great to be here. Thanks. How 0:04:45.680 --> 0:04:50.320 surprising or weird is this moment? You've been examining the 0:04:50.360 --> 0:04:53.760 world of market structure for a long time. How crazy 0:04:53.800 --> 0:04:56.880 are things right now? From your perspective, that's pretty insane, 0:04:57.279 --> 0:04:58.800 you know, if you look at if you look at 0:04:58.800 --> 0:05:02.760 equity volumes. While we didn't hit a record during during 0:05:02.800 --> 0:05:06.120 February March, we you know, in terms of share volume, 0:05:06.279 --> 0:05:09.960 we pretty much almost doubled the amount of notional traded 0:05:10.040 --> 0:05:11.360 and that has a lot to do with the lack 0:05:11.400 --> 0:05:15.560 of stock splits. But um, the amount of value turning 0:05:15.600 --> 0:05:20.600 over is just phenomenal, given given traditional history, and even 0:05:20.839 --> 0:05:23.680 this is through the global financial crisis, through the dot 0:05:23.720 --> 0:05:27.839 com meltdown, the volume has just been astronomical. And and 0:05:27.920 --> 0:05:31.120 actually the other thing you got to go provide kudos too, 0:05:31.279 --> 0:05:35.679 is the market infrastructure. We really haven't seen now. Robin 0:05:35.720 --> 0:05:37.719 Hood was was down for a day or so, but 0:05:37.800 --> 0:05:40.720 other than that, you know, you've seen very few outages 0:05:40.960 --> 0:05:44.360 and and and given all the volume, and especially over 0:05:44.400 --> 0:05:48.880 a prolonged period, the brokers, the exchanges, the infrastructure providers 0:05:48.920 --> 0:05:51.440 have really done a great job keeping up with it. 0:05:52.040 --> 0:05:54.799 I mean, robin Hood was down at a pretty critical 0:05:54.839 --> 0:05:58.080 time in retrospect. But before we get into all of that, 0:05:58.360 --> 0:06:01.000 what do you think is driving through retail interest in 0:06:01.320 --> 0:06:03.880 stock trading at the moment. Is it as simple as 0:06:03.920 --> 0:06:06.720 everyone being stuck at home and having nothing to do, 0:06:06.880 --> 0:06:10.880 or is it people who saw the federal reserve response 0:06:11.000 --> 0:06:13.800 and assume that it would lead to a big rally 0:06:13.960 --> 0:06:16.839 in risk assets or is it something else. I think 0:06:16.839 --> 0:06:19.880 you've got a couple of different factors going on. First, 0:06:19.960 --> 0:06:22.760 I think the initial issue was a freak alpium that 0:06:22.839 --> 0:06:26.359 everybody realized that, hey, the the economy may come to 0:06:26.400 --> 0:06:29.520 an end, and you know, we might have this pandemic 0:06:29.560 --> 0:06:32.880 of global proportions that they kind of erect the economy. 0:06:32.960 --> 0:06:34.560 And so I think a lot of people got on 0:06:34.760 --> 0:06:37.680 sold a lot that you know, that would would explain 0:06:37.720 --> 0:06:40.440 a lot of the big dips and reallocate their portfolios. 0:06:41.200 --> 0:06:44.040 Then I think, you know, the economy started shutting down 0:06:44.040 --> 0:06:46.320 in mid March. People were stuck at home, there was 0:06:46.360 --> 0:06:49.760 no sports, there was no there was no nothing um 0:06:49.839 --> 0:06:51.880 and you still had a lot of volatility. And then 0:06:51.920 --> 0:06:53.960 I think you start getting into this whole you know, 0:06:54.040 --> 0:06:56.560 I'm stuck at home. What do I do? And then 0:06:56.560 --> 0:06:58.960 you've got also a lot of professionals that are also 0:06:59.080 --> 0:07:01.560 stuck at home with nothing going on and a lot 0:07:01.560 --> 0:07:05.680 of volatility. And then you start seeing things like Amazon. Oh, 0:07:05.760 --> 0:07:08.240 you know, I'm gonna go. I'm gonna go buy everything 0:07:08.240 --> 0:07:10.280 from Amazon. It's going to come the next day. So 0:07:10.320 --> 0:07:14.800 you've got logistics pops, You've got you online pops, and 0:07:14.880 --> 0:07:19.440 you've got the hotels you know, and entertainment sector shutting down, 0:07:19.480 --> 0:07:23.720 so you have a lot of interesting plays and thoughts around, hey, look, 0:07:24.160 --> 0:07:26.680 this sector may actually do really well, but the sector 0:07:26.760 --> 0:07:29.400 might actually do very poorly. So you've got some real 0:07:29.440 --> 0:07:33.080 directional bets. Whereas over the last decade it's really, you know, 0:07:33.120 --> 0:07:37.160 the secret to life has mostly been throw everything in 0:07:37.200 --> 0:07:40.240 the sp five and just let it grow. So now 0:07:40.280 --> 0:07:43.600 you actually have directional bets that you can play, and 0:07:43.960 --> 0:07:46.040 so I think you've got to You've got a whole 0:07:46.120 --> 0:07:49.680 bunch of factors. Plus, of course, you know, commission free brokers. 0:07:49.720 --> 0:07:52.680 We started to see the you know, in December, when 0:07:52.680 --> 0:07:55.080 we started to see Schwab and the other guys kind 0:07:55.080 --> 0:07:58.480 of throwing the talent commissions. You start to actually see 0:07:58.520 --> 0:08:02.520 the retail participation tick off. Actually, then it didn't just 0:08:02.600 --> 0:08:06.720 happen in February March. It really started December when when 0:08:06.760 --> 0:08:24.240 folks brought their commissions down to zero. Actually, I want 0:08:24.240 --> 0:08:26.920 to back up for a second. So we introduced you 0:08:27.240 --> 0:08:31.440 as the head of market structure research at Bloomberg Intelligence. 0:08:31.880 --> 0:08:34.920 But UM, talk to us a little bit about your background, 0:08:35.480 --> 0:08:39.120 but also market structure What does that mean? I don't 0:08:39.120 --> 0:08:42.440 know if like that term is a particular one that 0:08:42.520 --> 0:08:45.120 people have a grasp on when they hear it. And 0:08:45.160 --> 0:08:49.520 why is it something that itself should needs to be understood? 0:08:49.760 --> 0:08:53.120 Why why you should people know more about the sort 0:08:53.160 --> 0:08:56.640 of vague, big picture concept of market structure and why 0:08:56.720 --> 0:09:00.079 is it worth researching? Well, certainly my wife doesn't understand it, 0:09:00.440 --> 0:09:04.800 but market structure researches is basically not necessarily what people 0:09:04.800 --> 0:09:08.679 are buying and selling and whether IBM is expensive or cheap. 0:09:08.800 --> 0:09:12.720 It's how all of the infrastructure fits together. So it 0:09:12.840 --> 0:09:14.439 used to be, you know, we used to have a 0:09:14.480 --> 0:09:18.640 New York Stock Exchange floor and people wandered around and 0:09:18.679 --> 0:09:23.680 negotiated and we're specialists and floor brokers. Um. And then 0:09:24.040 --> 0:09:27.280 NASTAC was over the counter, mostly traded on traders desks. 0:09:28.080 --> 0:09:31.120 But over the last twenty years, basically all of this 0:09:31.240 --> 0:09:35.760 has been electronified. And so we now have thirteen fourteen 0:09:35.840 --> 0:09:40.199 exchanges soon to be sixteen exchanges. In US equities, we 0:09:40.240 --> 0:09:44.640 have sixteen options exchanges. And the pricing structure and how 0:09:44.679 --> 0:09:47.559 all this fits together and how do they connect and 0:09:47.720 --> 0:09:49.880 who do you route to first, and what types of 0:09:50.000 --> 0:09:53.040 orders do you put where? And how do you measure 0:09:53.200 --> 0:09:56.400 whether you're you're getting a good fill or not. That's 0:09:56.440 --> 0:09:58.599 all it has to do with all the rules and 0:09:59.080 --> 0:10:03.760 mechanisms the markets are engaged to actually match fib consellers together. 0:10:03.760 --> 0:10:06.760 And this occurs not just in U S dequities, but 0:10:07.400 --> 0:10:10.120 fixed income. You're starting to see electronification of the fixed 0:10:10.120 --> 0:10:14.599 income markets, and that's much more complicated and fragmented than equities, 0:10:15.040 --> 0:10:18.240 UM and foreign exchange and and so you're seeing the 0:10:18.320 --> 0:10:22.840 movement and the electronification of all of these markets, and 0:10:22.920 --> 0:10:25.720 it has tremendous ramifications in terms of how your orders 0:10:25.720 --> 0:10:29.520 are executed. And so that's that's basically what market structure researches. 0:10:29.600 --> 0:10:32.960 So it starts with the rules and regulations and then 0:10:33.040 --> 0:10:36.160 translates into how all of these rules from regulations are 0:10:36.160 --> 0:10:40.480 adopted through exchanges and and the market infrastructure. I gotta 0:10:40.520 --> 0:10:42.760 say I used to call Larry up quite a bit 0:10:42.760 --> 0:10:45.280 when I was writing market structure stories over at the FT, 0:10:45.480 --> 0:10:48.920 and he was always very generous with his time and insightful. 0:10:49.040 --> 0:10:53.200 So thank you, Larry. Um, let's connect the market structure 0:10:53.480 --> 0:10:58.160 argument to what's going on with the commission free brokerages 0:10:58.280 --> 0:11:02.960 or trading offers I mentioned in the intro. There's this 0:11:03.000 --> 0:11:06.559 weird thing. You're offering someone the ability to trade for free, 0:11:06.800 --> 0:11:11.560 but obviously that trade is generating a cost somewhere in 0:11:11.600 --> 0:11:16.280 the system. So how exactly are those trades being funded? Yes, 0:11:16.360 --> 0:11:20.400 so this is really an interesting topic, and so at 0:11:20.400 --> 0:11:24.040 the very highest level it sounds really fishy. Um, you 0:11:24.080 --> 0:11:28.440 mean that market makers and wholesalers are actually paying to 0:11:28.600 --> 0:11:32.640 execute against my trades as a retail broker there as 0:11:32.640 --> 0:11:35.920 a retail investor. How can that be good? They must 0:11:35.920 --> 0:11:38.680 know something that I don't know. They must be ripping 0:11:38.679 --> 0:11:41.040 me off, They must be giving, you know, getting me 0:11:41.080 --> 0:11:45.880 a horrible execution. Um, this can't be right. Actually, though, 0:11:46.120 --> 0:11:49.839 it's not necessarily as nefarious as it all sounds. And 0:11:49.880 --> 0:11:52.600 first of all, there are two different payment for order 0:11:52.600 --> 0:11:55.880 flow screens. First there's equities, which which works one way, 0:11:55.920 --> 0:11:58.720 and then there's options, which actually is a whole different 0:11:58.760 --> 0:12:01.520 way that's a little more challenging. What we can talk 0:12:01.559 --> 0:12:03.360 a little bit that about that if we have time, 0:12:03.920 --> 0:12:08.079 um the equity side, So think about equities and think 0:12:08.080 --> 0:12:11.080 about an electronic platform. So at the heart of an 0:12:11.160 --> 0:12:14.439 electronic matching platform that works in microseconds, and all of 0:12:14.520 --> 0:12:18.760 these exchanges now execute in microseconds, if not quicker than microseconds, 0:12:18.760 --> 0:12:23.520 basically hundreds of nanoseconds, which is an unfathomably fast amount 0:12:23.559 --> 0:12:26.480 of time. So me, as a market maker, what what 0:12:26.520 --> 0:12:29.360 am I doing? I'm putting out a bid the buy 0:12:29.480 --> 0:12:34.400 or sell Apple, okay, And and so all of these 0:12:34.600 --> 0:12:38.959 really smart, really high frequency trading firms are looking at 0:12:39.000 --> 0:12:41.360 my quote to buy or sell Apple and trying to 0:12:41.440 --> 0:12:46.320 determine if that's the appropriate price for this nanosecond basically 0:12:46.360 --> 0:12:50.520 for this microsect and if it's wrong, it's either not 0:12:50.520 --> 0:12:52.520 going to trade if I'm too high or too low. 0:12:52.559 --> 0:12:55.360 But if I'm too aggressive, I'm gonna get taken out 0:12:55.480 --> 0:12:58.960 in that in a heartbeat, in in the microsection. So 0:12:59.800 --> 0:13:03.240 me as a market maker, I have to you know, 0:13:03.360 --> 0:13:07.160 if I'm trading on lad exchanges. I have to ensure 0:13:07.240 --> 0:13:11.080 that I'm really confident in my quote, and confident in 0:13:11.080 --> 0:13:13.880 that my quote not just in terms of trace here 0:13:13.960 --> 0:13:17.839 Joe or Larry trading against that quote, but confident in 0:13:17.920 --> 0:13:22.359 that quote for a big, huge mutual funds, high frequency traders, 0:13:22.720 --> 0:13:24.880 and the smartest hedge funds in the world to trade 0:13:24.880 --> 0:13:28.520 against that quote. Um, because the second that i'm you know, 0:13:28.559 --> 0:13:31.480 are the microseconds that I'm wrong, I'm gonna get taken out. 0:13:31.840 --> 0:13:34.120 So the quote that I provide really has to be 0:13:34.160 --> 0:13:38.560 an institutional quote, a quote that that you know, hedge 0:13:38.559 --> 0:13:41.960 funds and mutual funds need to think, Okay, you know 0:13:42.040 --> 0:13:45.600 that's a fair quote, not too aggressive, not to to lose. 0:13:46.559 --> 0:13:50.360 That said, the reason why, um, they're thinking that is 0:13:50.400 --> 0:13:53.920 because they're trying to buy thousands of not hundreds of thousands, 0:13:54.000 --> 0:13:57.800 if not millions, of shares. You and I are are 0:13:57.840 --> 0:14:00.840 trying to buy a hundred shares are increasingly less than 0:14:00.840 --> 0:14:03.679 a hundred shares. But that's a whole another topic about 0:14:03.679 --> 0:14:07.439 AUTI loots to promote the title of this podcast, in effect, 0:14:07.880 --> 0:14:11.760 because you're in my order is for a fraction of 0:14:11.840 --> 0:14:16.920 the shares of Fidelity or Capital Group or Bridgewater or 0:14:16.920 --> 0:14:20.440 whoever's trying to buy, I can price you're in my 0:14:20.680 --> 0:14:23.800 order tighter because you know, because I don't have you know, 0:14:23.880 --> 0:14:26.840 because Larry doesn't have a million shares after that first 0:14:26.920 --> 0:14:30.560 hundred share share order behind it. So if you think 0:14:30.560 --> 0:14:32.800 about supply and demand, what does the market do? E 0:14:32.800 --> 0:14:35.080 gauges supply and demand, And if there's not a whole 0:14:35.080 --> 0:14:38.520 lot of supply or demand, then the price should not 0:14:38.640 --> 0:14:41.360 change that much um Whereas if there's a lot of 0:14:41.360 --> 0:14:43.720 supplying demand that the price will change a fair amount. 0:14:44.400 --> 0:14:49.840 But theoretically, actually retail trades should actually price more aggressively 0:14:49.960 --> 0:14:53.320 than than the larger orders. And that's kind of the 0:14:53.320 --> 0:14:57.240 theory behind aiming for order flow, that a market maker 0:14:57.280 --> 0:15:02.840 could actually priced mire your shares better then they can 0:15:02.840 --> 0:15:07.040 price a large mutual funder heads fund. And the savings 0:15:07.080 --> 0:15:11.560 that gets split three ways. It gets split up into 0:15:12.000 --> 0:15:15.320 price improvement, which basically means that they're gonna they're gonna 0:15:15.360 --> 0:15:18.600 give me the customer a better price. They're going to 0:15:18.880 --> 0:15:23.280 pay a few cents to the broker that the retail 0:15:23.360 --> 0:15:25.720 broker who were outed that water flow to them, and 0:15:25.760 --> 0:15:28.800 that's the payment for water flow part. And then the 0:15:28.840 --> 0:15:32.160 third part of course, is the wholesaler's profit. And so 0:15:32.360 --> 0:15:35.840 that is if you think about it, that that's that's 0:15:35.880 --> 0:15:40.160 the philosophy behind internalization and equity payment for water flow. 0:15:41.440 --> 0:15:44.600 All right, there's a lot there, So let's try to 0:15:44.800 --> 0:15:47.920 unpack it a little bit further. So you've made this 0:15:48.000 --> 0:15:51.680 distinction between say, if if me or Tracy you want 0:15:51.680 --> 0:15:56.560 to buy ten shares of apple Um, then the market 0:15:56.640 --> 0:15:59.600 maker at the other end can price you, said, I 0:15:59.600 --> 0:16:03.800 think more aggressively or give a so a narrower spread 0:16:03.800 --> 0:16:07.480 because they feel more confident. Yeah, because because you're not 0:16:07.480 --> 0:16:09.480 going to come on the back of that with another 0:16:09.520 --> 0:16:17.000 hundred another hundred an ad shares. So when Schwab last 0:16:17.120 --> 0:16:20.960 year announced that they were going to go commission free, 0:16:20.960 --> 0:16:23.080 everyone's like, yeah, well they can do it because they 0:16:23.080 --> 0:16:27.440 have this huge float of other assets and they make 0:16:27.480 --> 0:16:29.920 money in a bunch of ways. But that's obviously not 0:16:30.080 --> 0:16:33.280 the case with robin Hood, which doesn't have you know, 0:16:33.320 --> 0:16:35.160 which doesn't have nearly the asset base, that has a 0:16:35.280 --> 0:16:37.720 very different business model, that doesn't have the bank attached 0:16:37.760 --> 0:16:39.960 to it like Schwab does. It doesn't have all the 0:16:40.120 --> 0:16:44.040 R I, A, S, etcetera. So just let's walk through 0:16:44.120 --> 0:16:49.160 specifically the innovation on say the robin Hood side a 0:16:49.200 --> 0:16:53.360 little bit further and how payment for order flow works there. 0:16:54.040 --> 0:16:56.840 I opened up my robin Hood app. I make an 0:16:56.920 --> 0:17:01.880 order to buy ten shares of Apple. Explain to me 0:17:01.960 --> 0:17:08.480 specifically how robin hood makes money after that transaction without commissions. Well, 0:17:08.640 --> 0:17:10.960 they make them their their money pretty much the same 0:17:10.960 --> 0:17:13.679 way that swab are a merry trade or each trade 0:17:13.880 --> 0:17:16.240 you know, doing that trade, get is going to get 0:17:16.320 --> 0:17:20.840 routed to most likely Citadel, Virtue or Susquehanna through the 0:17:21.160 --> 0:17:23.359 city har E tr And just just to stop you 0:17:23.480 --> 0:17:25.840 real quickly when you those are the market makers when 0:17:25.880 --> 0:17:30.840 you were talking about Okay, so these entities like Virtue, Citadel, 0:17:31.440 --> 0:17:34.879 uh and so forth their market Suscohana their market makers, 0:17:35.520 --> 0:17:39.240 their market makers. Yeah, and so they're going to route 0:17:39.280 --> 0:17:43.280 that order flow to generally one of those three players. 0:17:43.480 --> 0:17:45.679 They're the three largest, and there are a couple of 0:17:45.720 --> 0:17:50.240 other auxiliary players there too, like six, like two sigma. 0:17:50.400 --> 0:17:53.200 So they're gonna wrote that order flow to those guys. 0:17:53.560 --> 0:17:58.080 The wholesalers are going to execute that equity order at 0:17:58.119 --> 0:18:00.440 we're better than the best price in the mark because 0:18:00.480 --> 0:18:04.800 that's how the SEC demands that those those orders get 0:18:04.800 --> 0:18:08.199 executed and they're gonna pay. They're going to probably give 0:18:08.240 --> 0:18:11.280 a little bit of price improvement to the order so 0:18:11.320 --> 0:18:13.959 that you'll get a price that it's actually better than 0:18:14.000 --> 0:18:17.280 what you see in the marketplace, and then they're going 0:18:17.359 --> 0:18:21.280 to pay robin Hood a few cents for that order. 0:18:21.520 --> 0:18:24.400 And it could be you know, it could be anywhere 0:18:24.520 --> 0:18:28.359 from the average payment for order flow is about fourteen 0:18:28.400 --> 0:18:31.159 cents per hundred shares, but actually in robin Hood it's 0:18:31.200 --> 0:18:34.600 it's more. Yeah, I wanted to I wanted to ask 0:18:34.640 --> 0:18:37.520 you about exactly this, and I think maybe it will 0:18:37.520 --> 0:18:40.159 help us understand the process more. But one of the 0:18:40.240 --> 0:18:44.160 criticisms of robin Hood especially is that it tends to 0:18:44.200 --> 0:18:49.400 get more for every dollar in you know, customer order 0:18:49.520 --> 0:18:54.199 flow versus someone like Schwab. Why is that? What's the 0:18:54.240 --> 0:18:58.080 difference there, because presumably everyone is sort of executing at 0:18:58.119 --> 0:19:00.719 at similar prices, or at least execut eoting with with 0:19:00.800 --> 0:19:06.439 the same intent of achieving best price. Yeah, that that 0:19:06.480 --> 0:19:10.240 gets a little square me. So, So if you think about, 0:19:10.440 --> 0:19:15.080 you know, the three sections of profit, you know, the 0:19:15.119 --> 0:19:18.480 price improvement, the payment for water flow, and the market 0:19:18.480 --> 0:19:21.480 maker profit. So if you think about it, the spread 0:19:21.520 --> 0:19:23.280 is going to be the same whether it's you know, 0:19:23.320 --> 0:19:25.920 whether you know it's you or me, are coming from 0:19:25.920 --> 0:19:29.280 Schwab or robin Hood or each free. So the bigger 0:19:29.400 --> 0:19:31.520 question is how much am I going to make on 0:19:31.560 --> 0:19:34.280 that trade? And how is that what I make going 0:19:34.320 --> 0:19:37.240 to be split between what I keep, what I send 0:19:37.280 --> 0:19:39.200 to the client and what I send to the broker 0:19:39.720 --> 0:19:42.760 and what I what I keep will probably be somewhat 0:19:42.800 --> 0:19:47.679 consistent because it's very competitive, and so the real differences 0:19:48.119 --> 0:19:50.919 between what I what I give to the client and 0:19:51.000 --> 0:19:55.640 what I give to to the broker. And and while 0:19:55.640 --> 0:19:59.640 they don't have, um the execution quality stats, that's where 0:19:59.680 --> 0:20:02.960 there could be different you know, um that robin Hood 0:20:02.960 --> 0:20:05.720 may keep a larger percentage or a smaller percentage, or 0:20:05.760 --> 0:20:09.040 give you a larger percentage back to the client or not. 0:20:09.560 --> 0:20:13.119 And that's where there can be some variability. How do 0:20:13.160 --> 0:20:17.720 you measure execution quality? Execution qualities usually measured by the 0:20:17.840 --> 0:20:20.399 spread and the percentage of the spread that goes to 0:20:20.440 --> 0:20:23.160 the market maker versus the percentage of spread that goes 0:20:23.200 --> 0:20:27.600 to the client. And and we've seen those numbers actually 0:20:28.080 --> 0:20:32.520 very significantly over the last twenty years from basically the 0:20:33.240 --> 0:20:38.280 broker or the market maker keeping the full spread, the 0:20:38.320 --> 0:20:43.760 only keeping roughly about of half the spread, actually keeping 0:20:43.760 --> 0:20:45.919 half the spread because everything is measured on half to 0:20:45.960 --> 0:20:49.960 spread between the midpoint and the execution price. So it's 0:20:50.000 --> 0:20:53.240 gone over the last twenty years from the market maker 0:20:53.400 --> 0:20:57.879 keeping basically the whole half spread versus they're only keeping 0:20:57.920 --> 0:21:02.200 about half the spread. And so it's all measured between 0:21:02.200 --> 0:21:06.800 the execution price and versus the displayed price. And it's 0:21:06.800 --> 0:21:11.600 a measurement called e Q effective over quoted ratio and 0:21:11.680 --> 0:21:19.280 that's part of the SEC's reporting requirements for retail execution. 0:21:19.880 --> 0:21:23.840 So we're seeing, you know, we're seeing much better execution quality. Now. 0:21:23.920 --> 0:21:28.280 That execution quality differs, you know, can differ really depending 0:21:28.359 --> 0:21:32.679 upon what the broker's priority is. Do they want to 0:21:32.680 --> 0:21:34.920 get paid or do they want to give that money 0:21:34.920 --> 0:21:36.480 to the client. So you can look at let's just 0:21:36.560 --> 0:21:41.200 say Fidelity. Fidelity doesn't take payment for water cloth from 0:21:41.760 --> 0:21:46.320 retail clients. So all of that, all of that money 0:21:46.359 --> 0:21:51.040 that comes back in effect from the wholesaler um goes 0:21:51.119 --> 0:21:55.479 directly to the client. Whereas folks like Robin Hood probably 0:21:55.520 --> 0:21:57.879 take a little bit more, Shub takes a little less, 0:21:58.080 --> 0:22:02.359 but you know, it really is a dialog most depending 0:22:02.440 --> 0:22:06.080 upon what what the pretail brooke will wants. So I 0:22:06.080 --> 0:22:09.040 want to press you a little bit on best execution 0:22:09.280 --> 0:22:13.399 and best price as well, because one of the criticisms 0:22:13.520 --> 0:22:16.520 of commission free trading or payment for order flow is 0:22:16.600 --> 0:22:20.520 that even though you're trading for free, you might not 0:22:20.640 --> 0:22:24.639 necessarily be getting the best price. And that's you know, 0:22:25.280 --> 0:22:30.000 even though you're dealing in smaller retail orders, um that 0:22:30.160 --> 0:22:33.679 market makers can execute at tighter spread. So can you 0:22:34.280 --> 0:22:36.840 can you sort of walk us through that argument? And 0:22:37.000 --> 0:22:41.440 what is what is the opportunity that retail investors are 0:22:41.520 --> 0:22:46.680 missing out on when their trade goes to a payment 0:22:46.760 --> 0:22:51.760 for order flow provider versus a different system. You're you're 0:22:51.760 --> 0:22:54.840 starting to get into a little complicated areas here, So 0:22:55.280 --> 0:22:57.320 let's let's make it a little let's make it a 0:22:57.359 --> 0:23:01.000 little simpler, and then we'll add some complexity to Generally 0:23:01.000 --> 0:23:04.359 what happens is since the wholesaler receives the order and 0:23:04.440 --> 0:23:08.320 executes it off exchange, they then can manage the risk 0:23:08.440 --> 0:23:12.240 and execute it and executed at a tighter price than 0:23:12.920 --> 0:23:15.720 you know what can happen on the exchange. So without 0:23:15.760 --> 0:23:19.320 the without the whole, without the wholesaler. In effect, what 0:23:19.359 --> 0:23:21.560 would happen is that order would go to an exchange 0:23:21.600 --> 0:23:25.200 and that would trade on the bid or on the offer, okay, 0:23:25.359 --> 0:23:27.560 or you know, if it traded in the dark, it 0:23:27.720 --> 0:23:31.240 might be executed at a mid price, but by and large, 0:23:31.440 --> 0:23:33.359 if it goes to an exchange, it's going to be 0:23:33.440 --> 0:23:36.399 traded at the bid or the offer. The whole saler 0:23:36.480 --> 0:23:39.600 is going to give you uh an inside price, a 0:23:39.680 --> 0:23:42.320 price that's better than the bid of the offer. So 0:23:42.880 --> 0:23:46.159 the whole idea that that the wholesaler is kind of 0:23:46.240 --> 0:23:49.439 ripping you off. That doesn't really fly, especially when you 0:23:49.480 --> 0:23:53.159 start seeing prices that are tighter than the best bid offer, 0:23:53.720 --> 0:23:56.200 because you wouldn't necessarily get that. If you routed to 0:23:56.320 --> 0:23:59.840 an exchange, you would generally get the bitter offer. Now, 0:24:00.880 --> 0:24:04.280 adding a little bit of complexity to this is that 0:24:04.400 --> 0:24:09.320 in most cases, odd lot orders are not displayed, and 0:24:09.320 --> 0:24:14.080