App-based broker Robinhood Markets Inc. has become the new way to play the stock markets, with a focus on millennials and the promise of commision-free trades, the Wall Street Journal writes. However, this $5.6 billion company has to make money somehow — and the way it does has proven a little controversial, according to the publication.
In Come the High-Frequency Traders
Robinhood sends customer orders to high-frequency traders for cash rebates — known as payment for order flow — and, according to Robinhood co-founder Vlad Tenev, this allows them to cover operational costs and offer commission-free trading, the Wall Street Journal writes.
This practice can benefit clients because they can get better prices than on public exchanges, but this only holds true if brokers pass on that benefit, known as price improvement, the publication writes. Unlike other firms that practice payment for order flow such as Charles Schwab, E*Trade and TD Ameritrade Holding, Robinhood does not publish data on price improvement, according to the Wall Street Journal. This means that Robinhood likely executes trades at a slightly worse price than other brokers, according to market veterans, the publication writes.
If the broker placing orders with a market maker demands high payments, the trader will widen their spread to ensure profits, negating price improvements, according to the Wall Street Journal. This appears to be the case with Robinhood, which, according to SEC filings, can get up to 60 times more cash than a firm like Schwab for an order, the publication writes.
However, Robinhood could still be valuable for investors looking to make frequent trades with small numbers of shares, since savings on commissions offset possible price improvement, the Wall Street Journal writes. If an investor is looking to trade hundreds or thousands of shares, however, the benefit of price improvement at a rival broker could outweigh commissions, according to the publication.
