The wholesaler buys it at the real price, say $10.01.Your broker sends it to a wholesaler, an electronic market maker for retail customers.We have discussed payment for order flow several times before, in more sensible and less cynical ways, but on the cynical model all PFOF is is: This model is too cynical, but I think it accurately captures why people are mad about payment for order flow for retail stock trading. If you knew that the real price was $10.01 you’d be mad, but you don’t for all you know the real price was $10.03, you got it, and you’re doing great. The market maker who sold you the stock is happy because it can buy at $10.01 (the real best price) and sell at $10.03 (the price-improved, better-than-NBBO-but-still-worse-than-real best price). You try to buy stock, the national best offer is $10.05, your broker says “good news, we got you price improvement, you’re filled at $10.03.” You are happy because you got a better price than the NBBO you got the great-customer discount you might even have gotten the real price, what do you know. What you want is to get “price improvement,” to execute at some price better than the NBBO, so that you think you might be getting the real price.Īnd so the game for the expert intermediaries selling you the stock is to sell it to you at some price between the lit best price and the real best price. This model is so widely understood that executing trades at the NBBO is often considered bad. If they sell you stock at the NBBO, they will do well - on this model, they can buy stock at the real best price and resell it to you at the NBBO, keeping the difference for themselves - but if you are sophisticated you won’t keep coming back. If they sell you stock at worse prices than the NBBO they will get in trouble. Their goal is to (1) make money for themselves and (2) keep you coming back. The goal of the expert intermediary selling you the stock is … well, their goal is complicated. Your goal, as a person looking to buy or sell stock, is to find the real best price, by scouring dark pools and knowing a lot about markets and routing orders cleverly, or by having a trusted intermediary do that for you. Prices 2 and 3, the “real” best prices available in dark pools and hidden liquidity and internalizers’ books and so forth, are not certain sorts of experts know what they are but most people have to guess at them. Prices 1 and 4, the NBBO, are transparent anyone can see what they are. The national best offer is the best price you could find to buy the stock on a lit stock exchange.The “real” best offer is the best price you could find to buy the stock if you knew where to look.Say there’s some dark pool somewhere where someone has a hidden order to buy the stock at $9.99 if you find that order you can sell at $9.99. The “real” best bid is the best price you could find to sell the stock if you knew where to look.The national best bid is the price you’d get if you tried to sell the stock on a lit stock exchange.If you start from that premise you can build a model in which there are basically four different “market” prices for a stock. I want to stress that this is rough and inaccurate if you work for a stock exchange, or for an electronic market maker that quotes on the exchanges, you don’t have to email me to be like “actually our quotes are great.” I just mean that, to understand what people get mad about in market structure, it is often helpful to start from the premise “they think the NBBO is bad.” Somewhere, in the dark, there are hidden orders at better prices, and if you and your broker are any good you will find them. That is just the sticker price, the advertised price, the price for rubes. You can go to a public stock exchange and see a “lit,” public bid and offer for every stock the exchange will tell you at all times, like, “you can buy this stock for $10.05 or sell it for $9.95.” (The best buying and selling price available on all the lit exchanges is called the “national best bid and offer” or NBBO.) But if you ever find yourself paying the lit price to buy a stock, or accepting the lit price to sell it, you have done poorly. equity market structure is that the prices on the stock exchange are bad. Bad PFOFĪ rough, inaccurate but useful way to think about U.S. Programming note: Money Stuff will be off tomorrow, back on Monday.