July 22, 2020

The Daytraders

 

A year ago, Karen and I were flying to Fiji, 24 hours of travel from Denver to LA, to Auckland, to Nadi.

We took a ferry out of Denarau Island into Nadi Bay and north toward the Mamanuca Islands, all the way past the castaway home for television’s Survivor Fiji to our South Pacific gem, Tokoriki.

It’s not that I wish now to be a world away.  We can ride bikes past this gem, Catamount Lake, any crisp Steamboat morning (while the fruited plain radiates, it’s 45 degrees most days at 630a in northern Colorado).

It’s the shocking difference a year makes. Everybody’s trading. Instead of going to Fiji or whatever.

Schwab and Ameritrade have a combined 26 million accounts. Fidelity has 13 million in its brokerage unit. E*Trade, over 5 million.  Robinhood, the newest, has 13 million users.

Public companies wonder what impact these traders have on stock prices.  The old guard, the professional investors, seem to be praying daily that retail daytraders fail.

In some sense, the Dave Portnoy era (if you don’t know Barstool Sports and Davey Daytrader – perhaps our generation’s most adroit marketer – you must be a hermetic) has pulled the veil off the industry. It appears the pros know less than they led us to believe.

The pros say just wait.  The wheels are going to come off the retail wagon in a cacophony of sproinging springs and snapping spokes.

Of course, as Hedgeye’s Keith McCullough notes, if the wagon splinters, we’re all in the smithereens because there’s just one stock market.

We wrote in our widely read June 10 post, Squid Ink, about what happens to the millions of online retail trades.  They’re sold to what we call Fast Traders, machines that trade everything, everywhere, at the same time and thus can see what to buy or sell, what to trade long or short.

How does this flow that Citadel Securities, the biggest buyer of retail trades, says is now about 25% of market volume, affect the stock market, public companies and investors?

Two vital points about market structure here.  First, market-makers like Citadel Securities enjoy an exemption from rules governing stock-shorting.  Second, Fast Traders run trading models that predict in fleeting spaces how prices will behave.

Put these two factors together and you have the reason why stocks like TSLA can double in two weeks without respect to business fundamentals – or even the limitations of share supply.

If three million accounts at Robinhood want fractional exposure to TSLA, the problem for Fast Traders to solve is merely price and supply.  If you go to the grocery store and they don’t have shishito peppers, you go home without shishitos.

If you’re a retail trader wanting TSLA, you will get TSLA, and the price will rise, whether any shares exist or not.  Fast Traders will simply manufacture them – the market-maker SEC exemption on shorting.

The market-maker will cover before the market closes in 99% of cases.  So the market-maker isn’t short the stock anymore.  But maybe TSLA will have 25% more shareholdings than shares outstanding permit.

Worse, it’s impossible to understand supply and demand. If market-makers could only sell existing shares – back to shishito peppers – TSLA would skyrocket to $5,000 and plunge to $500.  Frankly, so would much of the market.

Which is worse?  Fake shares or fake prices?  Ponder it.

And machines will continuously calculate the supply or demand of shares of a stock versus others, and versus the exchange-traded derivatives including puts, calls and index futures (oh, and now Exchange Traded Funds which like prestidigitated shares have no supply limitations), to determine whether to lift prices.

As we said in Squid Ink, we believe Fast Traders buying order flow from retail brokers can see the supply in the pipeline.

Combine these features. Fast Traders see supply and demand. They relentlessly calculate how prices are likely to rise or fall. They manufacture shares to smooth out imbalances under SEC market-making exemptions.

And the market becomes this mechanism.

Risks? We’ve declaimed them for years.  The market will show a relentless capacity to rise, until something goes wrong. And then there won’t be enough stock to sell to meet redemptions, and prices will collapse. We’ve had tastes of it.  There will be more.

But it’s not the fault of the daytraders.

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