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Rebate trade

Rebate trade is an equity trading style that uses ECN rebates as a primary source of profit and revenue. A couple of years ago, you said you thought rebate trade was coming to an end. I read lately where you are now applauding some changes that make rebate trade valuable again.

Most ECNs charge commissions to customers who want to have their orders filled immediately at the best prices available, but the ECNs pay commissions to buyers or sellers who "add liquidity" by placing limit orders that create "market-making" in a security. Rebate traders seek to make money from these rebates and will usually maximize their returns by trading low priced, high volume stocks. This enables them to trade more shares and contribute more liquidity with a set amount of capital, while limiting the risk that they will not be able to exit a position in the stock. Rebate trade was pioneered at Datek Online and Domestic Securities. Omar Amanat founded Tradescape and the rebate trading group at Tradescape helped to contribute to a $280 million buyout from online trading giant E*Trade.

There are many ways to make (and lose) money day trading in the stock market. Most day traders invest in a stock hoping the company will continue to grow and become more profitable. Other traders don't watch stocks but watch other traders instead. They "bet" on when market players will buy and sell stocks, selling stocks "short" to profit from a trend. Still others will buy and sell huge volumes of well-traded stocks to cash in on rebates offered by ECNs (electronic communication networks), or digital trading floors.

How to trade?

  1. Buy a large volume of stock, bypass a middleman broker and post your shares directly on an ECN. When you have a buyer, the ECN will take a fee and kick you back a rebate. Hence you'll earn a rebate trading profit.
  2. Get out when you can post even a tiny one or two-cent profit. Waiting for larger profits usually results in a net loss, since the stocks traded on ECNs are so very liquid. If you see a price start to rise and you want to wait for a profit, rest assured that other rebate traders are watching the same price and may cut out before you do. The key is to take a low rebate and get out ASAP.
  3. Know that it's not whether the stock gains or loses in a day, it's how many transactions you facilitate that allows you to take advantage of the rebates offered by ECNs. Use your access to ECNs in every time zone to maximize your day trading profit.
  4. Trade in as much volume as possible, since rebates can be a fraction of a cent per share. Volatile, frequently traded stocks are usually chosen by rebate traders, since small numbers of trades will rarely yield a worthwhile profit, even if they are very large trades. This methodology relies on frequency rather than size.

Now, let's do some redefining of "rebate trade." A few years ago, there were several Canadian firms that were doing really well gaming the system. I know someone who owned a pretty large firm up there, and he explained that they would simply hire 19-year-old video game players and show them how to provide liquidity in low-priced stocks, collecting money on each side of the trade. The firm would negotiate a single price for commission on each of a handful of symbols. The traders would only be allowed to trade these specific symbols and share in the proceeds.

For example, the firm would pay $250 per day to a usually second-tier clearing firm to cover the execution costs. Then they would charge the trader what seemed to be a ridiculously low commission rate whenever they traded. They would park orders on the bid and offer of these symbols and collect up to a 20-cent per 100-share fee for providing liquidity. If they could keep their costs under that number, they could make money, and they did for years. It's my understanding that this model has now become outdated or is under the radar of regulators.

On the plus side, and what caused my renewed interest in collecting rebates, is the advent of better "smart" order routers within the industry. For example, we can first route orders to hit the destination, like SigmaX or ARCA, to collect the largest rebate amount. We can also use hot keys to route orders to the best possible destination for our needs. For example, I will park an order on the ARCA ECN if I want to be filled, but not such a priority that I "must" be filled. If I pay, say, 40 cents per 100 shares, and collect 20 cents or more for providing liquidity, then my commission costs are cut in half. Even the primary exchanges like the NYSE are now paying for providing liquidity. Be sure to check with your broker to see if they are "flowed through" to you, or if they keep them at the firm.

Now, sometimes we have to be filled right now. So we must hit the bid or take out the offering price in the stock. We can get paid for "taking" liquidity as well. Not usually as much, of course, but we can negate the cost of taking liquidity at the higher-priced market centers. For example, on ARCA, our traders would "pay" 30 cents per 100 shares for taking liquidity, and collect 20 cents for providing liquidity. But we get paid from 1.5 cents to five cents to take liquidity on EDGE or BATS ECNs. These prices vary based on various parameters. The trader was collecting about 45 cents for 200 shares for providing liquidity several times and paying 25 cents for 100 shares for taking liquidity, with other examples thrown in. Traders have saved or made a couple thousand dollars per month with proper order routing.

Stock market for beginners

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