How do “free” online brokers make money by selling order flows?


I keep reading that free stock broker companies make money by selling their “order flows”. How do they make money from this and why is anyone willing to buy “order flows” for more money than just the bid/ask price of each transaction?

In: Economics

* In the case of RobinHood, large wall street firms would not only buy the flows, but also act as the seller to the RH user.
* They would see what the RH user wanted to buy, then they would get it from the market at a better price and then sell it to the RH user at a slight profit.
* If they do enough volume of this, they make a bunch of money.
* This is also called “front-running” and depending on how exactly it’s carried out, might be illegal.

The market is full of intermediaries who act as “market makers”: they don’t have a view on whether the price of something will go up or down, they are just always willing to buy it for a bit less than it’s worth and sell it for a little more than it’s worth. So they do millions of transactions each day, and they lose money on maybe 49% of them and gain money on 51% of them. That small difference is enough to make these firms profitable.

If you’re in that kind of business, it is really important to know who is buying and selling stuff at any given time, because what you really don’t want to do is buy stuff up from someone who knows the price is going to go down and is trying to get it off their hands. So for these people it is important to know what retail investors are doing because typically retail investors do not have access to privileged information – they are price takers, rather than price makers. So they pay brokerages to know what their clients are buying and selling so that they can understand if they are just part of normal market transactions or if they are getting run over by a big buyer or seller who is causing a big price move.