Mad Hedge Technology Letter
September 23, 2022
Fiat Lux
Featured Trade:
(CORPORATE TECH NOTCHES ANOTHER WIN)
(HOOD), (SEC), (VIRT), (SEC), (HFT)
Posts
The US Securities and Exchange Commission (SEC) will stop short of banning payment for order flow, which is essentially high-frequency trading (HFT) firms buying the trading history of retail traders.
I believe this was a huge mistake because it inserts an unneeded middleman between the trader and his profits while raising the costs to the trader.
Why do HFT want the trading history in the first place?
They have algorithms built in place that reveals trends in the data allowing them to profit off it.
I guess one might be able to argue that this could also lead to big losses if algorithms are built wrong.
However, much of the time, the profits are risk free by front running the retail traders’ orders by buying and selling in the microsecond after the retail trader clicks buy and receiving the shares.
The outcome is earning a few pennies.
However, multiply that over million and billions of trades each year and that is why CEO of Citadel Ken Griffin has a net worth of over $30 billion and the Founder and Chairman of Virtu Financial (VIRT) Vincent Viola owns the NHL’s Florida Panthers.
Risk free trades work 100% of the time so their trades are never exposed to losses.
Granted, they had to build out the tech expertise and technological infrastructure to pull it off.
In the end, US regulators have been quite tight lipped on what might actually happen, and any move could make Griffin’s and Viola’s HTF companies less profitable.
It’s still a massive victory for the HFT industry as CEO of the SEC Gary Gensler walked back threats of banning payment of order flow.
That is now off the table.
Funnily enough, HFT firms argue they are delivering “greater liquidity” to the end buyer, but that liquidity is almost always in the form of a higher price.
Cynical and straight forward people would call this a rip off.
The flip side is that platforms can offer commission-free trading in the US.
Since 2019, most major online brokerages haven’t charged retail clients fees for their transactions, following a model made popular by Robinhood.
As for the here and now, Virtu’s stock isn’t a buy because the downdraft in the broader tech market has punished Virtu’s stock.
Remember, HFT firms can only front run orders for market orders and not limit orders that specify a certain price.
As for trading platform Robinhood (HOOD), this means that their stock isn’t a zero either, but they bet big on crypto and that investor base in now impoverished.
Citadel and Griffin announced $4.2 billion in net trading revenue in the first 8 months of the year which is a 23% year-over-year bump.
The outperformance occurred because they have gained market share from bigger investment banks and remember that they earn revenue on sell orders as well as buy orders.
Sadly, for investors, Citadel is a private company.
Ultimately, it’s not a good time to buy Robinhood or Virtu Financial, but strategically, selling any large tech rally makes sense as the macro risks of interest rates still rock the market on a consistent basis as high inflation roars along.
Mad Hedge Technology Letter
June 10, 2022
Fiat Lux
Featured Trade:
(STOCKBROKERS SIGNALING BIG CHANGES AHEAD)
(VIRT), (HOOD), (CITADEL)
Virtu Financial, Inc. (VIRT), Robinhood Markets, Inc. (HOOD), and Citadel Securities will need to change business models after the SEC plans unprecedented market changes so that high-frequency trading companies cannot front-run retail orders anymore.
Citadel is the only one of these 3 that is not public and for the other 2, heavy short interest will attract these stock names.
It’s about time.
The regulation revolves around retail investors finally getting a fair order for their market stock orders.
Market orders aren’t specified at a certain price and because of that, companies front-run these orders and skim a few pennies off their orders, before finally selling them to the end retail investor.
Crazily enough, this has been legal for many years, which is why the CEO of Citadel Ken Griffin can buy a new $100 million property every year.
Under current rules, brokers must perform “reasonable diligence” to determine the likely best market for executing a trade.
Robinhood Markets essentially sell historical retail trade data to Citadel and Virtu, better known as Payment for order flow (PFOF).
This is the juice that these HFT firms use to front-run the retail traders by deploying their professional algorithms.
Nobody in the trading community thought the SEC would get their heads around and do something about this egregious loophole in trading.
I need to give credit where credit is due, and diverting market trades into an auction where the actual best price is procured for the retail trader finally gives power back to the little man after getting fleeced for so many years.
CEO of Virtu Douglas Cifu and Ken Griffin must now expose their capital to risk if they wish to make money in markets.
What a thought!
The zero-risk era of front-running trading is coming to a close meaning companies like Robinhood are worth zero since their profits come from PFOF.
HOOD is worth zero because they don’t charge traders for trading fees because they package all revenue in the form of PFOF.
If that is now worth zero, then do the math: the company is also worth nothing.
This would also take down one of the biggest crypto-based companies whose claim to fame was being the rock-solid broker for the crypto traders.
Well, it’s hard to make money when your customer goes bankrupt, which is exactly what happened to crypto traders since November 2021.
Now, imagine charging for trades and competing with real brokers in the vanilla game of stock broking and the future looks quite daunting.
On the plus side, VIRT and Citadel can roll their mass profits into risk-based trading strategies. However, that could lose money, which they aren’t used to.
This is still only a proposal and not legislation yet, so the dust has yet to settle.
However, if this does come to pass, expect trading commissions to come back in full and no more free trading, because stockbrokers need some way to make money if they can’t sell your trading data.
The gamification of trading by HOOD has alerted the SEC to tighten down the hatches; and this has been coming for quite a time.
The SEC has proven in the past that when there is a red target on one’s back, they usually don’t just give a pass.
As a response to the SEC proposal, HFT brokers are pedal to the metal with lobbyists and government pressure to block this proposal.
If this proposal goes through in some potent form, expect HOOD and VIRT to be down big and for Ken Griffin to purchase less $100 million mansions.
