Retail investors get free trades because wholesale market makers pay retail brokers for the privilege of trading with their customers’ orders, which means that the retail brokers can make lots of money without charging commissions. They get good execution because it is very pleasant for those market makers to trade with retail orders, which are less dangerous, less likely to suffer from adverse selection, than institutional orders on the stock exchange, and the market makers compete with each other to execute those orders efficiently, and if they do not give retail orders good execution then the retail brokers will send the orders to other market makers. I am not going to rehash this in detail because nobody ever changes their mind, but I have written about it extensively here.
Everybody is mad about it because it seems fishy. Surely if market makers are paying retail brokers for order flow it is because they are up to no good. The market makers seem to be getting pretty rich, while the retail traders often … aren’t. And certainly it seems like a conflict of interest: If the retail brokers are getting paid to send their orders to market makers, how can you trust that they’re doing the right thing for the retail orders?
So now everything is going to be different:
The Securities and Exchange Commission is preparing to propose major changes to the stock market’s plumbing as soon as this fall.
Chairman Gary Gensler directed SEC staff last year to explore ways to make the stock market more efficient for small investors and public companies. While aspects of the effort are in varying stages of development, one idea that has gained traction is to require brokerages to send most individual investors’ orders to be routed into auctions where trading firms compete to execute them, people familiar with the matter said. …
The most consequential change being discussed would affect the way trades are handled after an investor places a so-called market order with a broker to buy or sell a stock. … Under the auctions being considered by the SEC, different firms would compete with each other to fill an individual investor’s trade, according to people familiar with the agency’s plans. Such a mechanism would fundamentally alter the business model of wholesalers, which can make more money by trading against small investors than they do on public exchanges, where they might find themselves trading with other sophisticated trading firms or institutional investors.
Will this be good for retail execution? The wholesalers say no, though they would:
Doug Cifu, Virtu’s chief executive officer, said the SEC should be careful not to make changes that unintentionally make trading more expensive. “Order-by-order competition …….