You might have seen the news: Reddit users have sent US markets into mania by sparking a multi-billion-dollar rally in stocks like GameStop.
It’s been billed as a mammoth power struggle between sophisticated short sellers and a bunch of retail traders with laptops.
But what you might not know is the game is rigged.
That’s because commission-free trading platforms like Robinhood make millions of dollars selling intel on their traders to institutional investors such as hedge funds – the very people Reddit’s army is rebelling against.
These companies then plug the data into computer programs that beat retail traders to the punch before the whistle even blows.
The practice is known as Payment for Order Flow (PFOF), and in recent years it has become widespread in the US as zero-commission retail trading platforms have grown in popularity.
Luckily for would-be sharemarket speculators in Australia, ASIC banned the practice Down Under in 2014 after the UK outlawed it in 2012.
That means — at least on paper — that data from Australian retail traders shouldn’t be flowing to institutional investors via PFOF deals.
And now there are calls for the US to follow the UK and Australia’s lead.
Prompted by a surge in first-time investors flooding into GameStop and becoming products for hedge funds in the process, retail trading platforms like Robinhood are copping heavy criticism over conflicts of interest.
On Monday, US-based retail trading platform Public caved and announced it would no longer participate in PFOF.
In a blog post, the company said the rising popularity of zero-commission trading had been focused on market democratisation, but at the cost of transparency.
“We’ve given a lot of thought to the future of our industry and have come to the conclusion that most players have been following each other — without actual leadership,” the company said.
“To do the right thing for our customers, we have to lead the industry with first principles thinking, and proper values … Public will stop participating in Payment for Order Flow.”
Instead, the platform has introduced a new optional tipping feature, which is basically a pay-as-you-feel model.
Allan Goldin, chair of the Australian Shareholders Association, said it was encouraging to see a US-based platform follow Australia’s example and protect retail traders from exploitation.
“People who would normally be considered gamblers have found this new game called the sharemarket,” he told The New Daily.
“It’s [open to] exploitation.”
But who knows how long that will last.
Regardless of how murky PFOF sales are, they’re incredibly lucrative for trading platforms.
In the first quarter of 2020, Robin Hood alone made the bulk of its revenue selling data to firms like Citadel Securities, Wolverine Securities, and Two Sigma securities.
Yesterday, leading US-based venture capitalist Bill Gurley said US regulator, the Securities and Exchange Commission (SEC), should fix the plumbing and ban PFOF sales.
“Payment for Order Flow (PFOF) smells bad all by itself, but the fact that it was pioneered by Bernie Madoff is a telling data point,” he tweeted.
The dodgy deals undermine the story being peddled by some media that Reddit members are taking on Wall Street by bidding up heavily shorted stocks.
Indeed, platforms like Robinhood have already asserted their supremacy over retail investors.
After being flooded with trades on selected stocks, the platform restricted how much users could trade, prompting an outpouring of criticism from users and even Tesla founder Elon Musk.
Mr Musk had his own angle, having battled short-sellers of his electric vehicle company, Tesla. But the irony is the restrictions also stopped the institutional investors from stealing the march on retail investors.
In the latest turn, Reddit users coordinating through subreddit /r/Wallstbets have started bidding up the prices of minerals like silver.
Silver prices jumped 13 per cent to eight-year highs on Monday, as the GameStop activity spilled into broader economy in what Goldin described as a “market distortion”.
Unlike GameStop, silver is actually a crucial metal in the manufacturing of electronics, being one of the most conductive minerals known to humanity.
That means sudden price increases have very real economic impacts extending far beyond the sharemarket.