November 22, 2017

Squab and Thanks

About 60% of US trading takes place on stock exchanges, the other 40% in private broker-operated markets. Should you be worried that nearly half of trading isn’t transparent?

It’s Thanksgiving week so there’s no need for worry! We’re in Vail marking the occasion because everything is better up high, and we’re grateful. And I think we’re entering a period of marked cooperation among exchanges, brokers, regulators and issuers, reason to be optimistic.  More on that in a moment.

Back to the question, worry stirs because there’s a notion that stock-trading in private markets called dark pools gets missed in reporting. Put that fear to rest. All trades are reported so there’s a consolidated volume figure for the day.

Let’s take an example.  Alcoa, you’re it, because your ticker is AA and easy to study. AA recently has traded about five million shares daily. Fidessa’s Fragulator says 59% of AA trading is at stock exchanges, with about 26% at NYSE-operated venues and the rest scattered across other stock markets.

The remaining 41% matches at dark pools or with brokers getting stock-trading orders internally and pairing buyers and sellers within the firm.

All trades are aggregated under reporting rules to create the observable five million shares of daily AA trading volume.

Why are investors and traders going multiple places to buy or sell AA instead of trading in one place?  A bit more math shows us.  AA trades over 28,000 times every day in roughly 175-share increments.

Data from Finra on how AA trades in dark pools or matches privately at brokers (gets “internalized”) shows trade sizes of 531 shares and 329 shares respectively.

That means the average AA trade at exchanges is tiny, near 100 shares. Arbitragers are behind a lot of those because they want to buy and sell as little as needed to change the price. While average market trade size is about 200 shares, a chunk of stocks trade under 100 shares at a time on average – a huge challenge for investors.

And there you have it. Big investors trying to buy and sell in size have no choice but to go where the average trade may be three to five times larger. It’s just efficient. That tells us too that there’s proportionally more investment behavior at brokers than what you see at exchanges.

What’s the good news here?  I don’t think I’ve seen exchanges so united behind bettering conditions for investors. All of them have publicly called on regulators for better market rules that help public companies do what they’re trying to do: Match compelling stories to long-term money via the mechanism of a public stock market.

That’s cause for thanks this season. I’ll go one further: I think we might in 2018-19 see Shangri-La:  A revamped 13F reporting structure with monthly long and short positions. The idea is percolating.

So, eat your stuffing and squab soaked in gravy, and go your way this 2017 Thanksgiving with happiness.  The market is weird, yes. Overpriced, yes. But there’s good news out there too.

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