How to Make Money Rebate Trading in the Stock Market

Aug 18, 2010
Daniel Peters

Rebate Trading Adds Up the Pennies Over Time - EPO

Day traders use rebate trading to profitably trade the stock market. What is rebate trading? How can you make money with it?

There are numerous strategies to make money in the stock market. Some day traders will buy and sell based on news items such as earning reports, or analyst upgrades and downgrades. Others use technical indicators such as the MACD cross-over and stochastics.

One technique is to trade for rebate credits offered by ECNs or Electronic Communication Networks. How are rebates achieved?

ECN Rebate Trading

Electronic Communication Networks, or ECNs for short, provide direct access trading. This computer platform allows buyers and sellers to 'meet directly' instead of being passed through a traditional broker yelling orders on the trading room floor. ECNs have an 'order book' for each stock being traded. Any trader, institutional investor, or broker that places a trade will be listed in the order book of the ECN being traded.

Are you confused yet? Allow me to decipher this a little. Imagine you are visiting a foreign country. You want to buy some fresh produce at the market. There are many options available:

Hire a local person to buy the produce for you.
Go down to the market yourself and buy from the first stand you see.
Locate a produce stand that is operated by 'a friend of a friend' or someone known to you.

Option 1 will be somewhat costly since you will need to pay extra for the middle man. This is similar to the investor/broker relationship.

Option 2 may lower costs somewhat since you are buying direct. However, the sellers may realize you are a visitor and charge you slightly more than a local. This is similar to buying directly through any ECN without regard to which one offers the best rates.

Option 3 takes patience but the payoff will be the produce you want at the lowest price. Certain ECNs will provide very good rates if you use their services.

Day trading and purchasing vegetables while on vacation are not that different.

ECN Fee Structure

ECNs will usually pay you a small rebate to buy at the bid and sell at the ask, while charging you for placing market orders.

When you place a limit order you are said to be adding liquidity.
When you place a market order you are said to be removing liquidity..

Below are some common fee structures as of August 2010. Amounts are listed on a per share basis.

ECN / Adding Liquidity / Removing Liquidity

EDGX (All) $(0.0023) / $0.0029
EDGA (All) ($0.0004) / $0.0007
ARCA AMEX ($0.0022) / AMEX $0.003
ARCA NYSE ($0.0023) / NYSE $0.003
BX (All) $0.0005 / all $0.0018

Sometimes the rebates are offered regardless of the exchange as in EDGX, EDGA, and BX. Other ECNs have varying rates depending on the exchange traded such as ARCA. It is good to watch rates closely as the constantly change and sometimes BX and EDGA offer rebates for market orders.

What are ECN Tapes?

You will often see the term 'tape' when placing orders with ECNs. What does the term 'tape' mean?

TAPE A = NYSE
TAPE B = AMEX
TAPE C= Nasdaq

These are some examples of what tapes a,b, and c mean, but the definition can also be wider.

Rebate Trading Strategies

How do day traders make money from rebate trading? Equity traders often look for highly liquid stocks, which means high daily volume, usually having millions of shares traded per day. Illiquid stocks are not suitable candidates as they can rise and fall with buy and sell orders, thus negatively impacting the net profit of the day trader.

Rebate traders are often very proficient at reading Level 2 quotes as well as time and sales feeds (T&S). Level 2 quotes show the different ECN orders and the price being asked. Time and sales printouts are displayed when a trade order is executed. The price, volume, and time are recorded. Day traders who watch the time and sales for any length of time are able to forecast a price jump based on speed of trades, and whether the orders are being executed at the bid or the ask.

High volume trades at the bid can be bearish
High volume trades at the ask can be bullish

Rebate traders try to buy at the bid and sell at the ask (or short sell at the ask and cover at the bid). Even if the stock moves one penny this can be a profitable trade.

Imagine that 1,000 shares are being traded. If the day trader adds liquidity by buying at the bid on EDGX, he earns $2.90. If he can then sell the stock one cent higher, his capital gains are $10. Furthermore, he gains an additional $2.90 by selling at the ask for a gross profit of $15.80.

He also has the option of selling at market price through BX for 10 cents rebate if he fears the stock has stagnated. He could earn $3 for this flat trade. The day trader should be careful that he does not engage in wash trades. This could occur if he traded shares back and forth to his friend collecting rebates with flat trades. This is illegal and could result in big trouble.

How Do I Get My Rebates?

Individual investors will need to deal directly with the ECNs to make an agreement for rebates based on monthly trading volume. Another alternative is to joining a proprietary trading firm such as Global Market Trading that will flow the full ECN rebate to you. The proprietary firm will likely charge you a small amount for each transaction or they will take a portion of your profits. In exchange you should get ECN rebates and extremely low transaction costs.

Rebate trading is a popular method to make money in today's stock market with ECNs. There is always a risk of losing money when trading in the stock market.