★ Trading Rebates: Adding/Removing Liquidity & Collecting ECN Fees
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What are rebates in trading? Trading for rebates or I get rebates for my trading. There are two definitions of this and the first one goes a long way back. An ECN is an electronic communication network. This is basically an automated system that matches buy and sell orders outside of traditional exchanges; such as the London Stock Exchange or New York Stock Exchange.
ECN Pass-Through Fees and Rebates
The other option is the ECN rebate for adding liquidity. Certain ECNs (Electronic Communications Networks) pay the buyer/seller for placing a limit order that adds liquidity.
An ECN facilitates the trading of financial products (outside of the traditional stock exchanges) and thus serve as Alternative Trading Networks (ATN). ECNs help make the market more competitive by providing swift execution, lowering transaction costs, transparency of order books and providing extra trading services above exchange trading hours. These ECNs will charge fees to the traders but they also pay fees to the market makers who are creating the liquidity. These market makers extract their cut by trading low priced, high volume stocks. They will continuously provide ask and bid spreads for traders and may trade many millions of shares in one day in lots of trades. The way that market makers limit their risk is by constantly settling their position and creating a new one which improves liquidity and allows the functioning of these ECNs, Market makers may also make more money by scalping small amounts which amounts to the difference between the ask and bid prices. The margins here are tiny but since these market makers trade a whole lot the profits can still add up (and they don't need to pay the brokerage)
How Does This Work?
The ECN would incentivize people to provide liquidity - i.e. they pay the buyer/seller for placing a limit order that adds liquidity. They do this by rewarding people by giving x pence/cents per share or percentage back on your trades. As such these parties would typically be sitting on both sides of the order book (buy and sell) with big orders and capture the spread as people trade plus any rebates from the ECN. Some of the bigger stocks now do without this additional liquidity and are electronic in nature. Examples of ECNS that may provide a credit structure could include ARCA, Nasdaq, BATS and EDGX. Each ECN will have slightly different credit and debit amounts.
Note: "Adding" liquidity happens when you BUY on the BID and SELL on the ASK, i.e, you're "adding" liquidity to the market.
"Removing" liquidity is the opposite, it's when you BUY on the ASK and SELL on the bid. In such circumstances you are removing liquidity from the market and hence pay the ECN fee.
For example BATS will pay you 0.0025 per share to add liquidity. So a broker may fullfill your 1000 shares order for MSFT stock and make $2.50 from the transaction by adding liquidity on BATS. The broker will then pay fees to NSCC (National Securities Clearing Corporation), the SEC, TAF (Trading activity fee) etc for the transaction. But even after all fees the brokerage will still get a margin of profit.
To simplify things a market order will remove liquidity (buy the ask, sell the bid) while a limit order adds liquidity (buy bid, sell ask). If you are rebate trading, then you will be on the top of the book (BBO), looking for a very high volume stock, and selling/buying when it moves a penny or less in your favor just to collect the rebate. If you're looking to adjust your cost base - enter/exit on limits to collect your rebate.
For instance, let’s suppose you place an order to sell 10,000 of BAC at $22.50, and the bid price is currently $22.49. If your order gets filled, and a market participant takes your offer, you would be considered a liquidity provider; and the party on the other side would be taking liquidity.
Are you a Liquidity Taker or Provider?
Rebate trading can be used in day trading as a way to profit from the market. Here instead of trader paying the commission for buying and selling, he is being paid by the service provider.
The strategy of rebate trading is to always bid and offer shares. Take the ticker S, for example. If I want to buy it, I bid at 2.5 for example. If I get filled, I can offer it at 2.52. Then I have added liquidity both ways.
Please note that I am not certain about those fees numbers. I’m not a rebate trader myself, I mostly remove liquidity.
The other type of trading rebates is perhaps a form that you are more familiar with if you're trading forex or indices. For instance if you trade with InterTrader they will give you a percentage back of your spread based on how much volume you do.