May 29, 2024

Sizing Trades

Size matters.  Does trade-size matter? 

The average trade in S&P 500 stocks is 87 shares this week (five-day average). Think about that. Quotes are in 100-share increments but the trades average less than the quote.

It can fluctuate around month-ends, index-rebalances, options-expirations. NVDA’s average is 47 sharesBut it trades about a million times per day, $40 billion of stock, about $40,000 per trade.  Incredible, mind-bending liquidity.

Should you care, investors and public companies?

Let’s use NVDA to answer.  NVDA is reverse-splitting its stock 10-for-1. What’ll that do to its trading? 

It’ll narrow the spread. If the SEC had its way, all stocks would be priced under $50 and trade at a penny spread, because the participants the market depends on – Fast Traders – won’t quit under those conditions.

The stock market only stays stable if there’s a continuous auction, the thrum of tiny trades. Here’s the trouble. If your timeframe is months or years, you don’t care whether the spread is a penny or twenty cents. You care about how much of it you can buy before the price changes. 

Take Gamestop, which has lately had some kind of trading requiem, a return from the dead to meme-stock status. Fleetingly.  It can trade a half-million times per day but per trade?  Just a couple thousand dollars.  NVDA, remember is $40,000 per trade.

Which thing will institutions buy?

Now, let me explain some things if I’ve lost you.  All stocks in the market are required to trade at or between the best bid to buy or offer to sell (called the NBBO, national best bid/offer).

Technically, it’s called the Order Protection Rule, or the Trade-through Rule, and it’s Section 611 of Regulation National Market System. Rule 611 prohibits trading at an “inferior” price than the best displayed bid or offer. 

That’s why in stock-trading, you can’t do what you can in real estate.  Say there’s a house you like on the market for $1 million (sooner or later, all the houses will cost that much – and then just the few will be able to buy or sell them) but other people are willing to pay that price. So you jump the market and offer $1.1 million. 

Now, you could put in a limit order to buy a stock for 10% more than the current price but why would you?  Unless your timeframe is more than a year, it’s a stupid thing to do. Generating a 10% annual return in equities is hard.

And the spread is the monetary gap between the bid to buy – which will always be the lower price – and the offer to sell.  The market was decimalized not by free-market forces but by Congress in 1997 through the Common Cents Stock Pricing Act, which forced stock-spreads to a penny from an eighth of a dollar (12.5 cents, tracing back to Spanish reals, “pieces of eight”).

But many stocks have much wider spreads than a penny.  SMCI, one of the market’s great successes, can have spreads of dollars. It trades only 32 shares at a time because it’s priced near $900. But it trades billions of dollars per day, nearly $30,000 per trade. It’s nearly as liquid as NVDA, the world’s most liquid equity.   

Consider this: SPXU, the 3x leveraged short Exchange Traded Fund from ProShares, routinely has a million shares at the bid and offer combined, with a penny spread (and most times the spread will be narrowed by a high-speed trader to about a tenth of a penny to profit by buying low and selling high in microseconds).

But SPXU is a one-day trading instrument.  Says ProShares:  While the Fund has a daily investment objective, you may hold Fund shares for longer than one day if you believe it is consistent with your goals and risk tolerance. For any holding period other than a day, your return may be higher or lower than the Daily Target. These differences may be significant.   

There’s a lesson. Stocks with narrow spreads and lots of supply at the bid and offer appeal to very short investment horizons.  Add in a low price and you have the magical recipe for day-trading. 

So, should issuers split their stocks so they’re priced between $20-$50?  There’s some merit to stimulating trading. At our decision-support platform for traders, Market Structure EDGE, we quantitatively screen volatile, liquid stocks with Demand/Supply imbalances, and the best ones for trading are priced below $50, statistically. 

But trading is not investing, and volume isn’t liquidity. Volume can be the same shares trading repeatedly. Meme stocks can trade more than their outstanding shares in a single day.  How?  Market Structure, market-making exemptions to short-locate rules, machines. Over time, tiny high-volume spreads consume shareholder-value. 

So, does trade-size matter? Money matters more. And that the SEC biases the market toward Fast Traders should concern us the most. 

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