Forefront Communications

Traders Magazine: The Incredible Shrinking Market

Alexandra Hamer

Alexandra Hamer

Client DASH Financial Technologies’ Stino Milito comments on the coexistence of retail and institutional players in US equity markets.

Retail-led irrational exuberance may or may not explain this week’s S&P 500 record highs, but 2020’s lockdown-inspired home trading explosion has reignited concerns about the uneasy coexistence of retail and institutional players in US equity markets. The conditions that are so attractive to newly active traders are leaving institutions feeling frustrated and restless.

Since March, a combination of zero commissions and an unexpectedly isolated, remotely employed and sports-deprived population has ramped up retail brokerage volumes significantly. Metrics vary, but the phenomenon is epitomized by Silicon Valley newcomer Robinhood, which reported 13 million customers in May, three record trading days in June and a new round of funding this month, pushing its valuation beyond US$11 billion. Overall activity has dipped from the highs of the early lockdown, but volumes are still buoyant at approximately 10 billion shares traded per day.

As a legion of armchair investors work on their stock-picking skills, they may be oblivious to their commission rate, best execution and price improvement advantages over institutional traders. They may also be unconcerned that they are less the customer and more the product in payment-for-order-flow (PFOF) deals that reap handsome revenues for their retail brokers, which sell their orders on to wholesale market-makers.

Wholesale market makers have seen their equity market share rise from around a quarter to a third in recent quarters, buoyed in no small part by retail flow. “If you don’t have direct access to these liquidity providers, you’re missing out on a lot of the market,” said Larry Tabb, Head of Market Structure Research, Bloomberg Intelligence. “Their aggregation of order flow also means they know the direction in which the retail segment is pushing particular names. Thus they are gaining an advantage from seeing the flows coming through their pipes.”

These flows add value to the wholesale market-makers, but only in the equity options market do they make their way onto exchange, otherwise being crossed internally.

“In both equities and options, retail investors know their orders will get filled at or inside the National Best Bid and Offer, but the market microstructure of the options market offers more opportunity for price improvement,” said Stino Milito, Co-COO at DASH Financial, a capital markets technology provider. In the options market, the wholesale market-maker will make a price to the retail broker, but the order must be executed via a cross on one of the 11 options exchanges, enabling other market-makers an opportunity to offer price improvement.

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