[vel0city]

> HFT & payment for order flow is what has made stock trading the low fee environment it is today.

I get how payment for order flow would help enable this current low upfront fee trading system we have today, they're managing to get their money from places other than direct fees. I don't exactly get how HFT also makes it low cost. Could you further explain that? Is it that mostly the people paying for the order flow is pretty much exclusively HFTs, and if they didn't exist the order flow market wouldn't exist?

Making up numbers here, if the HFTs manage to squeeze a dollar of profit out of the order flow data after buying my trade data for a dollar (two dollars of spread they manage to find), is that really better than me paying a dollar or two in fees for that order? It would be interesting to see the real values in question here on such things to actually gauge what is better for an average trader now trading in the low to zero fee trade market.

[steveBK123]

Spreads on bid/ask used to literally be at least 25cents, they didn't even use decimals. Would you rather pay 1 guy in a funny jacket with a palm pilot in NY 25 penny or a bunch of computer nerds sniping each other 1 penny?

Let's say you buy $10k of some $50 stock today and decide to sell tomorrow. In the old days you'd have paid say $10 to your broker to buy, and $10 again to sell. Your bid-ask spread in isolation of any price changes in the stock would be 25cents per share x ($10k / $50 = 200 shares) = another $50 in spread. So you're all-in transaction costs would have been $70.

Now you probably have a no-fee brokerage, and generally a penny spread. So same formula is 1cent per share x (200 shares) = $2 in spread + $0 in fees. So you're all-in transaction costs would be $2.

$2 vs $70 on $10k round trip investment. 2bps vs 70bps.

[Galanwe]

> I don't exactly get how HFT also makes it low cost

Because most HFT firms are also market makers. You can see them basically as middlemen that are mandated by the exchange to provide liquidity on both bid and ask by the market. These liquidity mandates reduce the spread for other traders, and in exchange market makers have lower, or even positive fees (i.e. they are _paid_ to trade).

Usually, market makers use these rebates to earn money by taking a passive order risk on behalf of an aggressive order from a flow they bought.

Think of it that way:

You're an exchange, you want people to trade on your platform, that's how you earn money.

For people to trade on your platform, you need liquidity, actual shares to buy and sell. So you invite market makers on your platform, and sign a contract with them, along the lines of "you have 0 trading fee but in exchange you need to provide $X of liquidity on bid and ask at any time and ensure a spread <Ybps".

Market makers accepting to on-board now have to somehow make a living while providing liquidity, but this is a risky business, because they are basically market making for people that are _more_ informed than them (they have adverse selection by design), and they have to respect their mandate of providing liquidity. That is, if a stock goes down, and people start selling it, the market maker still need to provide liquidity for sellers and buyers, which means maybe he will have to actually buy these shares that are tanking.

Usually the pure market making mandate is close to 0 profit, unless you spice it up with some other strategy. Taking passive order risk, netting order flow, maybe short term technical alpha, etc.

You can think of market makers and HFT basically as the same people. If you trade at high frequency, you're playing on micro changes in price, there's only so much a stock price can realistically move in 1s. HFT is only viable if you have very low, or no transaction cost. That's why there's a natural overlap between HFTs and MM.

[steveBK123]

And as a refresher for why HFT exists - it's a side effect of RegNMS. RegNMS exists because the guys in funny jackets in NY with palm pilots were ripping people off.

There was no consolidated tape and obligation for exchanges to route your order for Best Execution. There was no National Best Bid Best Offer.

There was just whatever price the exchange your broker sent your order to filled you at.

Some exchanges cough NASDAQ cough used to do things like display sub-penny quotes even though they only filled at full penny increments. So they could attract flow advertising prices they wouldn't file you at. See Rule 612.