Retail Investors, Brokers and The Grand Scam of Things

OK, I am going to try to be as straightforward as possible, but I think it's going to be quite hard for me not to hide that this is a topic that I loveeeee to talk about. And what are we going to talk about? We are going to talk about some integral and poorly lit corners of retail investing. If I had to put it into a biblical metaphor, "wolf in sheep's clothing" would be a good one. So, before anything, here is a small glossary:

  • Retail Investor: An individual or nonprofessional investor who buys and sells securities.
  • Securities: Fungible, negotiable financial instruments that represent some type of financial value.
  • Derivatives: Financial contracts, set between two or more parties, that derive their value from an underlying asset, group of assets, or benchmark.


As we know, companies are divided into shares of stock. You go to a broker and you can either buy shares or sell shares. The market price is the value of the last transaction between a buyer and a seller. The ask is the minimum price a seller is willing to sell, and the bid is the maximum price a buyer is willing to buy. When these two forces match each other, a transaction occurs.

Now, something very interesting about the stock market is that no one actually owns shares. It's all owned or, better yet, deposited in a company out of New York that holds the title for most shares in publicly listed companies. There are other companies around the world, especially in Europe, but you get the idea. Now, this is not some conspiracy theory; this is a well-known fact. It's used for the practicality of not having to do a deed of sale every time a security exchanges hands and to combat the inefficiencies of the "once upon a time" paper shares. The brokerage firm that you bought your shares from doesn't do business with this company, but probably through a giant bank or a market intermediary or directly with the exchange where the security is being traded. But the concept is the same. So, with this, what I mean is that when you blindly buy that share that your friend swears to God is going to be the next big thing but can't explain why and probably has an unhealthy obsession with Elon Musk, know that you were just part of an immense process just because you pressed buy on the app on your phone.


Depending on where you live, you are going to be using different brokers. If you live in the US, probably Robinhood, Charles Schwab, Fidelity, Ameritrade, IBKR (Interactive Brokers), or others, since it's an immense market. In Europe, there are local firms and banks in every country, as you can imagine. But what I see most people using are Degiro, Trading212, Revolut, eToro, and IBKR (Interactive Brokers). Wait? IBKR again? Yes, Thomas Peterffy, the CEO of the company (born Péterffy Tamás), is of Hungarian origin. He is not just a billionaire but also the inventor of the first electronic trading platform. He and his ginormous company decided to double down on expansion into Europe in 2020 after Brexit. Since most of their European customers were not UK residents, they started a new office to cover Central and Eastern Europe, in Hungary no less. Now, in the EU, they are licensed in Ireland, Luxembourg, and Hungary. Not that it matters a lot due to the passporting of licenses, but the key thing here is that brokerages have international structures to be able to operate in their desired markets and increase the pool of assets under management, or better yet, assets under transit. This is very important since most brokers nowadays don't charge a cent for buying and selling securities. Let's see how brokers that don't charge commissions on trading make money:

  • Percentage of interest on deposits (only works if interest rates are somewhat attractive)
  • Credit cards associated with the trading account
  • Interest for margin trading
  • Market making & payment for order flow

The first two are pretty straightforward. You deposit money, and they invest it in money markets, making them approximately 4-5% APY, and they give you a cut of that. Credit cards are something more recent, but they try to round your purchases and invest the said money in the platform. Plus, they make a percentage of the interchange fee every time you make a card payment.

The last two, "Interest for margin trading" and "Market making & payment for order flow," are the good stuff. When you trade on margin, you are borrowing money from the broker to trade securities. You hold leveraged positions with magnified gains but also losses. The usual interest is quite high. Market making & payment for order flow is where the money is at; let's talk about it.

Payment for Order Flow

Payment for Order Flow is basically allowing a big fish bank or market maker to have dibs on the orders that the common Joe places, so kind of giving them a separate market of sorts. Sometime your orders are sent to something called a dark pool, which is a private exchange where big institutions trade away from the public.

Your broker does this for money, in case you didn't realize. But why would companies be willing to pay for this, you ask? Well, there are ask and bid prices (we already talked about this), and the difference between these is called the spread. Market makers are market agents that try to provide liquidity to the market, making sure that orders by big institutions are fulfilled with the least amount of slippage (the difference between the expected price of a trade and the price at which the trade is executed) and that the market is liquid enough. Market makers then sell or buy the securities that you traded with them to funds and other financial institutions that want to reduce slippage (when they trade $100 million worth of shares, it matters a lot). Additionally, market data and analyzing soooo many juicy transactions can be very valuable. Exchanges also tend to incentivize market makers, claiming that it helps with the buyer-seller price matchmaking by reducing volatility and adding liquidity. And in case it crossed your mind, yes, brokers also act as market makers often.

So, Payment for Order Flow has its own regulations. Some countries allow it, some don't. But the one thing that doesn't change across any jurisdiction is the rule on best execution. This means that when your order is sold to the market maker or bank, you need to get the best price available. However, in this entire process, not just shares are traded. Plenty of other products can be traded at a brokerage firm. And I kinda lied when I said that you can only buy or sell shares. You can also short them (betting that they are going to go lower). So let's talk about derivatives and other things, other than buying and selling shares, and how they affect Retail Investors.

Complex Products

Regulators across the globe have been making the distinction between accredited investors (qualified investors in Europe) and unaccredited investors for a while. The thesis is that unaccredited investors have low technical and monetary capacity to analyze and mitigate risk, making them, or at least in principle, low risk tolerant. Regulators have come up with rules and methods to make sure it's safe, or fair, or at least to look like it, for regular people to participate in financial markets and make some money. The reality is that people don't make money. People lose money in the markets. COMMON PEOPLE CAN'T BEAT THE MARKETS BY PICKING INDIVIDUAL SHARES. If you want to make some cash, ask Warren Buffet. He will tell you to invest in index funds. Whenever you think you are winning, you are just following a trend that JP or Goldman have already made risk models and reports on, and they know when to get out, leaving you in the red. Remember, you are trying to beat the market, but you have lower, slower, and less quality information than the professional investors.

So, if we agree that retail investors are at a disadvantage against institutional investors, even in the most common basic financial instruments like shares, how can we allow people to play with options, margins, and futures that can literally make them lose everything? It's a market, people are in competition with each other, but here we are talking about an unfair fight. It's the fight of David and Goliath, but Goliath keeps winning. When that fund lost that shit-ton amount of money over the GameStop short squeeze, people were happy but mostly surprised due to the unlikeness of a big fish losing.

Final Thoughts and Conclusion

The market benefits from having retail investors due to their provided liquidity of around 20% of the daily trading volume, with this number definitely increasing in the future as financial products become more generally accessible. It's also worth noting that the industry had a massive boom after the pandemic. However, the question here is: Do retail investors benefit from being able to trade complex products? My answer is no. Nevertheless, I strongly oppose blocking them from accessing these products. We need to give people the opportunity. I propose, perhaps in ignorance, that brokerage accounts have a maximum realized loss per specific time period. So, if an account with $10k owned by someone making $50k a year ends up losing 90% in a single week from risky complex products, the account could be put on cooldown of some sort, preventing the investor from digging themselves into a deeper hole. I don't think it's worth talking about rules on leverage because that's already something the regulators already did and keep doing.

Note: We can regulate and regulate, but no one should be left behind. If a country somewhere offers brokerage licenses with little to no criteria and questionable regulatory practices, the investors from that country are easy prey for the market overlords.