In this post, I’ll talk about why you lose money on every trade. Learn why ‘free’ brokerages like Robinhood is actually very expensive below.

And no, I’m not going to give you the lecture saying “you lose money on every trade because you trade too much!”

Trading too much loses money – that much is obvious, so this post won’t address that.

This post addresses the fact that there are fundamental, hidden factors in the market that causes you to lose money on almost every single trade.

Less obvious.

How Front Running Works. And Why You’re Losing Money On Almost Every Trade

Suppose you want to buy 100K shares of $ABC, at market value.

The current market value is at $99. And there’s 100K shares available at $99.

Logically, you should be able to complete your purchase at $99/share.

Alas, you’re about to lose a lot of money. Here’s how—a high frequency trader can:

• See that you have 100K shares you want to purchase before the seller’s brokerage can.
• See that someone else has 100K shares they’d like to sell before your brokerage can.

Having this informational edge milliseconds before either brokerages is great. This is because the HFT guy can buy up the 100K shares at $99 before you do, and then sell it back to you at a new market price, say, $100. Congratulations, you just lost $100K.

“Oh but it doesn’t happen that often so I’d never get ripped off like that” – noob investor.

Wrong.

High frequency trading / arbitrage attacks make up about 50% of total trading volume. This means almost every trade is getting ripped off by these HFT guys. Example:

• 50% of total volume is from regular / institutional investors.
• 50% of total volume is the ‘mirror’ of the above transactions (i.e. HFT guys do the same trades as regular folks, but faster, and then give it back to them at a worse price).

Robinhood Steals From The Poor, And Gives It To The Rich

The above example requires high frequency traders to get information before either brokerage. But generally that’s not even required. It’s common practice nowadays for brokerages sell clients’ trade information (i.e. “order flow”) to HFT firms so that their clients could be taken advantage of.

This is why Robinhood and a lot of other brokerages offer ‘free’ trading. They don’t need to make money from you, because HFT firms pay them handsomely to take advantage of your orders.

Think about it: there’s no reason for brokerages to sell their client’s information if they could make more charging you $5/trade like in the old days. You can reasonably conclude these ‘free’ brokerages are making way more money selling your information so every single one of your trades is a lot more expensive.

As an example: Robinhood sells your trade information to Citadel so that Citadel can rape your orders every time you transact through Robinhood. Every trade you make, you’re paying for:

• Citadel Securities’ employees salaries, so they can continue raping your trades.
• The ‘bribe’ that Citadel Securities give to Robinhood so they can take advantage for your order.

In other words, 2 things are happening:

• Trading on Robinhood is literally paying Robinhood/Citadel to steal from you.
• Robinhood is stealing from the poor (you), so they can give the money to the rich (Citadel).

I say ‘stealing’ because Robinhood is not / never going to be transparent about how each of your orders are much more expensive than it needs to be. They’re going behind your back to take your money.

If they were transparent about it, it’d be more akin to robbery since they’ll take money right in front of you. But obviously if they had any clarity about how they make their money, you’d never trade with them.

High volume + lack of clarity = you and everyone lose money on every trade.

Can I Prevent This With Limit Orders?

Limit orders protect you somewhat, but not completely. You’ll still lose money on almost every trade.

You’ll still be front-run by high frequency trading firms, but you’ll know what the maximum you’ll pay for an order is.

Example: You want to buy 100K of ABC at $99/share limit.

• The going rate drops to $98/share, but HFT firms push the price back up to $99/share. You still pay $100K more than you need to as in the previous example, but you know your max capital invested. Whereas with a market order, an HFT firm could push the price up to $105 and you’re out $600K.

Potential Ways To Counter High Frequency Traders

First way to prevent front running is using IEX.

IEX is an exchange showcased in Flash Boys that’ll add delays to market information so that high frequency traders won’t be able to see any information quicker than the rest of the market would.

In other words: IEX adds a ‘fog of war’ that HFT firms can’t see through. The kicker is that you can’t trade through IEX directly and will instead need a brokerage that supports directing your orders through IEX so you won’t get screwed.

Apparently, TD Ameritrade allows you to do this. E-trade also allows you to do this apparently (in the same thread linked).

If you’re too lazy to change brokerages or route your orders through IEX manually, you can also consider just splitting up your trades. For example, if you’re buying 10K shares, you might just stagger buying 500 shares at a time, across 20 trades. The reason for this is because it’s quite likely that your 500 shares won’t be the only shares floating in the market. If, for example, the sell-side has 500K shares and you’re only buying 500 shares, it’s very hard to frontrun you because even if they bought 500 shares, there’s still 495,500 shares at the price you want. And if they buy 500K shares to try and profit off your 500 shares, it’s no longer ‘arbitrage’ for them. They have huge market risk because they need to now offload 495,500 shares profitably or at par, otherwise they lose money.

Making each individual trade smaller in volume makes it very difficult for high frequency trades to justify the risk of front-running you.

Another counter is to just think of it as you’ll pay an extra, hidden fee for each transaction you make. Thus, you should just buy and hold forever. Even if you get arbitraged out 1% of your limit ordertrade, you should be able to easily absorb that if you just HODL the S&P 500 for decades to come. Also, the fewer transactions you make (i.e. you just buy and hold forever vs. day-trading), the less you’ll lose out on these hidden fees.

High Frequency Traders Are A Detriment To Society

The most insidious thing that these firms do isn’t stealing your money. That’s just part of it.

What they do is inherently extremely dangerous because it adds a lot of volatility to the market. Responsible for 50% of the volume, HFT firms effectively unnecessarily doubles the amount of volume being pumped through the market.

This extra volume causes significantly faster, and higher price swings (also known as volatility). More, unnecessary volatility = unnecessarily higher ‘standard deviation’ = injecting risk to the market for no reason.

In sum: HFT firms are detrimental to everyone but themselves because they’re approximately doubling the risk for every single investor out there.

Suppose without an HFT firm, you can achieve a Sharpe ratio (measure of return vs. risk) of 5. With HFTs in the picture, your Sharpe ratio is cut in half.

You’d need to double your returns to achieve the same Sharpe Ratio where HFTs didn’t exist. This implies that your total risk-adjusted returns, over the long-term is cut in half because of HFT firms. So not only are you paying taxes on your capital gains, you’re actually paying a hidden 50% tax on your returns to these firms.

Counterargument: HFT firms will have the argument that they ‘help make the market more efficient’. Or they’re ‘solving for market efficiency’. GTFO. Because they don’t. Nor does it mean anything in their context. If HFT firms didn’t exist, the market will only be slightly less efficient (i.e. by a few seconds). The very slight (often undetectable) inefficiencies if HFTs and their families were erased from the Earth are much more preferable to people’s money being stolen in a non-transparent manner and doubling the risk to everyone in the market as a whole.

But also intuitively, these firms don’t add value at all. They’re just high-frequency hustling people out of their hard-earned money. Mom and Pop want to buy shares at $X? Well, they’ve got technology to force them to buy at $X + $.05 instead.

It’s Just Physics, And There’s Nothing We Can Do About It

But you can’t hate the player: you can only hate the game. Hating people for being systematically greedy is like hating gravity. You can’t hate physics.

If there’s a system that can be exploited, and is remarkably profitable, you’d do it too.

And that’s why HFT firms do it. It’s mostly done because it’s legal, profitable, and the attitude of ‘if I don’t do it, somebody else will. So why not capture this value that someone else would capture anyway? It’s not like if I don’t be greedy, it’d stop everyone else from being greedy.’

And there’s nothing we can do about this as a whole, other than using the countering steps above.

The legal system can’t penalize capitalists for taking advantage of public information. HFT firms are profitable because they know how to get the information milliseconds ahead of you.

Where I Got My Information

Most of this information I got from reading Flash Boys (this is the same author that did The Big Short). I’ve read some articles explaining front running and stuff before, but I don’t think anyone’s really ever explained it to me in such detail and in such layman’s terms as Flash Boys.

I highly recommend grabbing the book for a highly entertaining, yet educational read that can help you not lose money on every trade.

Disclaimer: The book link is an affiliate link. I get a few cents to help run this site, at no cost to you (unlike trading with Robinhood) should you buy the book with my link. If you hate me, you can just search for it on Amazon separately to make sure I don’t get any money.