Can Everybody Really Win?


As you all no doubt remember, almost five years ago we had a Flash Crash, where retail orders were specifically mistreated. The High Frequency Trading wholesaler system that normally piggybacks the public quote, and delivers retail fills for the online brokers somewhere around the NBBO, either shut off, or worse – cherrypicked (i.e. “providing liquidity” to the ones that suited them, and exhausting the rest to the market as repeated erroneous marketable limit orders that resulted in retail fills nonsensically away from the value of the stocks). Even the SEC-CFTC Joint Flash Crash Report acknowledged the failure of wholesalers that day:

Notable in the trading activity of May 6 was the redirection of order flow by internalizing and preferencing firms to Exchange markets during the most volatile periods of trading. While these firms provide significant liquidity during normal trading periods, they provided little to none at the peak of volatility.

Many positive changes have come about since that day, and in our opinion markets are better and more robust today, with better infrastructures and safety nets, as well as clearer guidelines on behavior of exchanges, dark pools, and trading participants. Credit for market improvements can certainly be given to hard work by our regulators, better market-structure-educated investors today (Books like Broken Markets, Dark Pools, Flash Boys, as well as our work in other media played a part in this, we hope!), and the closing of many loophole issues in the marketplace. Many unsavory players in the marketplace have also been shaken out. To summarize, markets are indeed better for everyone today compared with 2010.

This brings us to our morning note’s topic, and the article in Barron’s over the weekend by Bill Alpert titled, The Little Guy Wins! The article starts right away with Notre Dame’s Finance Professor Robert Battalio:

“When you place a market order today, you pay a lower commission, you get an immediate confirm, and very rarely are you getting worse than the price you saw when you pushed the button,” 

He is right. For retail traders sending market orders, or marketable limit orders, stock executions are cheap, fast, with predictable outcomes. The orders are bought by wholesalers, who have a free option to provide liquidity on the other side of the order, or exhaust it through. Most of the time, they exercise that option.

Over a period of months studied Barron’s ranked these wholesalers who pay the retail brokers like Ameritrade, Fidelity, Schwab, etc. for that free option we just discussed:


Barrons market makers


Barron’s ranked the wholesalers, and doing their own study (which they share via open source), they proclaim Citadel tops for providing retail traders with the most savings, as measured by net price improvement versus the NBBO. Barron’s discusses the use of two metrics – the average price improvement in actual money, and the E/Q ratio (effective spread versus quoted spread).

Again, the article concludes that the retail investor has never had it better, and that The Little Guy Wins. Alpert writes a piece that is very supportive of the way our stock market works, with embedded payment for order flow (PFOF), and that is very reassuring to retail investors that may have been scared by reading Michael Lewis’s Flash Boys.

Certainly, the large retail brokers, as well as the market makers in the story are thrilled with Barron’s piece.


We would like to make a few critical points, however, although we respect the thoroughness Alpert exhibited by conducting his own analysis when writing his article:

1)      Most retail investors, certainly by money managed, are with institutions, such as Vanguard, Putnam, Janus, and Capital Group. Michael Lewis’ Flash Boys really is talking about the experience of these “retail investors” in large asset pools. One need only to note the existence of Tabb’s Clarity product, or watch the media for frequent stories of dark pool/stock exchange abuse, or even note IEX’s success, to verify the very real adverse experience “retail investors” experience there.

2)      The Barron’s story talks nothing of what happens when an investor Bids or Offers for a stock, instead of deciding to “cross the spread”. It’s too bad, because ND’s Robert Battalio’s best work shows how bidding on EDGX yielded fewer fills, and stock price movements further away from an investor, compared to bidding on NYSE for example. Additionally, some stock exchanges tag these passive retail orders with an identifier, effectively screaming to the world, “Here doth lie an uninformed order!” Said differently, today’s market is horrible for retail investors if they ever try to be passive in their access to the quote. They will never get queue priority, and when they do get filled, the stock moves against them. The public quote has become non-diverse. It has become only a place for high speed players in today’s markets.

3)      When a retail trader finally cedes the game of being passive, and decides to cross the NBBO spread, as is the case with the analysis of all the trades in the Barron’s piece, the price improvement they are given by the wholesalers is measured versus a stale quote – a slower quote – the SIP. Is it really any wonder that wholesalers compete for a free option to be the other side of an uninformed order against an old quote?

From our perspective, payment for order flow (PFOF) is a horrible practice in our markets. In calm markets, its effects are mostly benign enough, especially for retail investors, as highlighted in Barron’s story. However, in more volatile or stressed times, the results of this distortion are very pronounced, and worse – unpredictable.

In terms of best execution, have we not lost our common sense when we as investors don’t ask why savvy short term trading firms that spend billions on technology compete to buy the right to touch our orders? If you are a broker with a responsibility to investors who use you, can you really look them in the eye, with a straight face, and tell them you are giving the best possible price in the markets by selling their orders to high frequency savvy short term traders, who have the option to execute against them versus a stale and slower quote?

There is a great deal at stake in the game being played by the participants featured in Alpert’s article:

–          $1billion in wholesaler profits

–          $600m in “benefits” to retail investors

–          $1billion in payments to online brokers selling investor orders


Truly, can everybody really win? Do any of you believe that?