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Denninger: So How Do They Make Money?

By Karl Denninger
2019-10-06 07:00

Schwab has announced it is going to "zero commission" on stock and ETF trades -- right behind IB, which pretty-much did the same thing recently.

TD, E-Trade and IB got butt-pounded instantly, and Schwab is not reacting well either.

Now let's remember that these firms are allegedly "asset managers." We're back to the same problem that the so-called social media have: They claim zero cost to you but that's not really true.

That ought to be obvious to anyone with more than two firing neurons -- you can't run a business making no money and remain in business. Therefore the question becomes where is the money coming from and the answer is ]always "You."

In the brokerage business the issue has always been a function of order flow payments -- that is, the broker gets paid to route your orders to one place or another. Why would someone pay for order flow? Because they're making money off it.

Who's paying? One of the parties in the transaction -- either you, the other guy (who was buying what you were selling or vice-versa) or, most-likely, both of you.

How are you paying? Through the spread -- that is, the difference between the buy and sell.

There is an alleged thing called "NBBO" (national best buy and offer) that is supposed to prevent you from getting hosed. That is, when you buy or sell a stock you're supposed to get executed at the best bid or offer in the market at that specific point in time.

The problem is that high frequency trading -- robotic algorithms -- have made it quite possible to game this, presenting the appearance of compliance or even factual compliance while functionally gaming the market and stealing money from you by effectively front-running the transaction. At the core of the issue is that the NBBO is calculated by a central party called a "SIP" and its latency is longer than the computer's -- by a lot. As a result it's entirely possible for the machine to get "in front" of your order and there's no way to prove it did on a predatory basis -- but these firm's wouldn't exist, nor would any other private connection if it didn't work.

So don't kid yourself -- while this is pounding the online trading market companies today it does not mean you're not paying for your stock trades.

You are.

It's just that the price is being hidden from you and it is almost-certainly higher than it would be if everything was fully-disclosed.

After all why would anyone hide facts from you and claim to make something "free" if it actually saved you money?

https://market-ticker.org/akcs-www?post=237012