In the corridors of Wall Street and at water coolers of large hedge funds you may hear the words “dumb money,“ a reference to money invested by the average retail customer. The hard-earned savings of middle-class Americans invested with the hope of growth for retirement, college and the like. These dollars generally flow through “retail brokerage” houses, whose no fee trading ads are widely seen on television commercials during prime time viewing
To hedge funds and other professional trading organizations on Wall Street, capturing “dumb money“ trades has become so lucrative that they pay a fee to these retail brokerages to direct those “dumb money” trade orders to them for purchase or sale. That practice is called PAYMENT FOR ORDER FLOW.
Payment for order flow has become so lucrative to the retail brokerages that many, if not all, now advertise “no fee” trading to their online retail investors. This naturally drives further “dumb money” investing, frequently online from the comfort of home, thus generating more profit for the retail brokerages and the large hedge funds.
Some hedge funds had such an arrangement with the online retail brokerage Robinhood, which yesterday (along with other retail brokerages with similar payment for order flow relationships) restricted trading in shares of Gamestop and other securities that have recently experienced a seismic increase in retail investor buying interest. Their decision to do so appears to directly favor their payment for order flow partners and at the same time handicap their middle-class investors, suggesting that when the “dumb money” gets smart, the “smart money” can just close the casino and shut them out. This apparent unfairness has outraged people, including lawmakers, on both sides of the political spectrum, and the issue seems destined to be the subject of future laws and regulations.
Hopefully this simple blog helps in understanding the more thorough media coverage such as this article in today’s New York Times.