It's not surprising that Robinhood gets paid the most PFOF per order of anyone in the industry - if you know what market makers need to succeed. A thread:pic.twitter.com/EnOdRCxasi
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In exchange for skimming $ from the spread, you take on some risk of the market moving against you. If an illiquid stock tanks while you're making a market for it, you end up buying a falling stock with no one to sell it to. That's a no no.
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You're a good market maker. You know how to avoid being a bag-holder. You stick to large-cap, liquid markets to help reduce the risk that no one shows up to offload your inventory.
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Your margins get so good that you're willing to pay brokers to give you trades that fit your strategy. Instead of drumming up interest in your market yourself, you give some $ to brokers to do it for you. That’s payment for order flow (PFOF).
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If you do venture out to less liquid markets (like options) you need traders that won't run away at the first sign of trouble. You need traders that aren't watching the order book for market imbalances. You need bag-holders.
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Enter Robinhood. Their clientele is almost exclusively the bag-holder type, enticed into trading with free stock, confetti, and dopamine hits. If you made a market for these trades, you could buy lower & sell higher with less fear that they'll run away.
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That is why Robinhood gets the best PFOF rates. Their retail order flow is the least risky, and MMs can make higher margins on it. With higher margins comes more willingness to pay for the privilege of taking orders. Fin
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