Takeaways from the GameStop Saga
Technology has narrowed a lot of gaps and hence competition between retail and institutional traders has become real in some parts of the stock market.
Retail traders have always been a disadvantaged group in the stock markets. Some of the advantages that institutional traders have long benefited from include:
Scale-advantage: Most of the institutional traders have large sums of capital which allow them to take simultaneous positions in companies and/or indices which retail traders could never imagine doing individually or even as a group together. This includes leverage (potentially up to 10x) that is available to them through their prime brokers. Scale becomes an advantage simply on account of the fact that most of the other market participants are kept out of certain trades.
Technology-advantage: Dedicated high speed leased lines, servers that are co-located in the stock exchanges, large computing capacities for crunching numbers, automated programming and trade systems with nano-second precision are available for most sophisticated traders. This gives them not just the technology advantage but also a significant time advantage in the market.
Information-advantage: Access to management teams, channel partners, institutional reports, broker networks are a number of sources of information that are available for institutional traders on a real-time basis. Retail investors have access to only parts of this information pool and that too with a significant lag at times. This information advantage has also been in the form of a group of institutions working together on trades while keeping retail out.
Market Access-advantage: Many parts of the financial markets are simply out of direct reach for retail traders — global currency, debt/credit, commodities etc. This essentially means that retail traders cannot take counter positions against their trades often leaving them unhedged or they cannot diversify their portfolios enough to mitigate overall risk.
Pied Piper Problem: Institutions have access to mainstream media through either broadcasting or social media platforms. This allows them to set the narrative for the markets and at times for specific scripts/indices/sectors as well. Most of them will be well meaning, but there are some pied pipers in every market.
It has never been a level-playing field between retail and institutional participants. The institutional traders have generated profits for their clients, for themselves and for companies that run these businesses. Retail investors have often been kept out of these pools by framing criteria that was either set by regulators or by the fund management companies themselves.
In the US, it has caused a lot of ire as some of these institutions were beneficiaries of government bailouts/loans during the GFC. This effectively meant that they taxpayers money was used to subsidize the rich investors.
So the retail traders have had to deal with all of these disadvantages for better part of history, but what has changed now? In a nutshell the answer is Technology. Like a lot of things on this planet, Technology has also democratized the markets in the last few years.
Let me attempt to elaborate how.
Ease of Access: Post the advent of high-speed internet, a lot of new age brokers have created cutting edge trading platforms that offer seamless, real-time access to retail investors. These platforms have the ability to run from any device (mobile, computer) and also work reliably on moderate internet bandwidths as well.
Computing Resources: There is a plethora of software solutions available on the internet for fairly complex computations like derivative pricing, creating customized strategies, back-testing, technical analysis etc. These have made available free by brokers in some cases or via subscription at nominal costs by independent service providers.
Low Transaction Costs: A number of low/zero cost brokerage platforms have emerged in the last couple of years provide traders with low to zero brokerage access. This is important in the context of trading as volumes tend to be very high and profit margins are thin.
Information Symmetry: Information access about companies in the internet world has become far more symmetric. Though there are some blind-spots that still exist, it is far better than what used to be the case a decade back.
Collective Thinking: Mainstream social platforms (Twitter, WhatsApp) and niche social platforms (Reddit, private forums) have created large groups of traders that allow them to freely exchange ideas, work on new strategies and collectively think about how to make money in the market. This has meant that thinking prowess employed by institutions is no longer a differentiator always.
So now that the monopoly of institutions in the markets has been challenged, they are retaliating by accusing the retail traders of irresponsible actions. For the time being, they do not have answers on how to deal with this sophisticated lot of retail traders.
Institutions, through media, have urged regulators to take actions under the garb of retail investor protection. As a result, some of the knee-jerk reactions that may emerge would make the markets even more institution friendly by either keeping retail investors out of certain pockets or making it even more difficult for them to participate.
It will be interesting to see how the situation evolves over the next few years but one things for sure — technology will democratize the market further as we move forward and all participants will need to evolve to maintain the edge and earn their economics.
