How brokers provide zero commission trading?
You've probably heard of many zero commission trading platforms being established.
Robinhood is probably the most well known one, actually.
Historically, brokers have made their money by facilitating trades in the market between buyers and sellers and collected a fee for their extremely hard work...
Since markets have become larger, with greater trading volume and more participants, commissions per trade have fallen drastically, and the industry has had to change for your poor broker to earn a living.
With the rise of the smartphone, this has led to brokers being able to target a new type of trader...
This trader tends to be less informed than a professional...
Trading off a phone...
A lack of experience...
And more of a gambling mentality rather than understanding what is truly driving markets.
Firms have realised that.
'Commission free' is a marketing tool, and a very good one.
See, what is happening now is that market makers and dealers - and by extension, exchanges - are willing to pay brokers for their uninformed clients' order flow.
High frequency trading firms, such as Citadel, Apex, Renaissance, Virtu and DRW conduct market making on extremely low timeframes, providing liquidity to exchanges - that's their primary goal - and exchanges pay them rebates based on volume for doing so - note the chart of the CME Group above.
Their share price has increased massively since high frequency trading (market making) has driven 'liquidity' to the exchange.
Since their business is focused around volume, they welcome HFTs providing liquidity and therefore do not mind paying them volume based rebates - HFTs are kind of like introducing brokers.
But what's a market maker?
Market makers are delta neutral.
They do not necessarily care about the direction of a market, they simply want to sell higher at the bid and buy at a lower offer, thus capturing the 'spread' (the difference between the bid and the offer).
By paying brokers for the uninformed flow, this means that they believe they can capture asset misvaluations, and therefore turn a profit.
And it's very lucrative business.
Robinhood recently got fined for not routing orders adequately to allow for best execution for clients.
The adverse selection that they committed is an example of how a client can be at detriment.
However, it isn't necessarily bad to trade with a zero commission broker, since your explicit costs can be low (although implicit - the costs you don't see - could be higher and likely are).
What matters massively is their execution policy and whether you are being filled at the bid or offer that the market will allow you, or if you're receiving the price that the broker wishes you to get as part of their routing relationships with market makers.
The former is good, the latter is bad!
I hope that's cleared up a bit for you...
Robinhood is probably the most well known one, actually.
Historically, brokers have made their money by facilitating trades in the market between buyers and sellers and collected a fee for their extremely hard work...
Since markets have become larger, with greater trading volume and more participants, commissions per trade have fallen drastically, and the industry has had to change for your poor broker to earn a living.
With the rise of the smartphone, this has led to brokers being able to target a new type of trader...
This trader tends to be less informed than a professional...
Trading off a phone...
A lack of experience...
And more of a gambling mentality rather than understanding what is truly driving markets.
Firms have realised that.
'Commission free' is a marketing tool, and a very good one.
See, what is happening now is that market makers and dealers - and by extension, exchanges - are willing to pay brokers for their uninformed clients' order flow.
High frequency trading firms, such as Citadel, Apex, Renaissance, Virtu and DRW conduct market making on extremely low timeframes, providing liquidity to exchanges - that's their primary goal - and exchanges pay them rebates based on volume for doing so - note the chart of the CME Group above.
Their share price has increased massively since high frequency trading (market making) has driven 'liquidity' to the exchange.
Since their business is focused around volume, they welcome HFTs providing liquidity and therefore do not mind paying them volume based rebates - HFTs are kind of like introducing brokers.
But what's a market maker?
Market makers are delta neutral.
They do not necessarily care about the direction of a market, they simply want to sell higher at the bid and buy at a lower offer, thus capturing the 'spread' (the difference between the bid and the offer).
By paying brokers for the uninformed flow, this means that they believe they can capture asset misvaluations, and therefore turn a profit.
And it's very lucrative business.
Robinhood recently got fined for not routing orders adequately to allow for best execution for clients.
The adverse selection that they committed is an example of how a client can be at detriment.
However, it isn't necessarily bad to trade with a zero commission broker, since your explicit costs can be low (although implicit - the costs you don't see - could be higher and likely are).
What matters massively is their execution policy and whether you are being filled at the bid or offer that the market will allow you, or if you're receiving the price that the broker wishes you to get as part of their routing relationships with market makers.
The former is good, the latter is bad!
I hope that's cleared up a bit for you...
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