Insights & Advice


The Retail Investor Jumps Ship

“The ES_F can’t get above the vwap and high volume node.”

“SPY –a perfect symmetrical triangle on the one minute.”

“Obama jobs report baked in. I’m short until tomorrow’s real report then we get a fluff rally.”

The above comments were lifted from a daily internet trading service peopled by day traders and other speculators. There are hundreds of them. Their comments make little or no sense to most readers, nor should they. Yet, in order to compete in today’s stock markets as an individual investor, this kind of investing behavior is required. Is it any wonder that individual investors are abandoning the stock market in droves as the reality of how the markets have changed hits home?

Even before the so-called ‘flash crash’ on May 6, 2010, the retail investor was, at best, risk adverse when it came to the stock market. Burnt badly in 2008 when individuals lost as much as $20 trillion of their net worth, retail investors continued to withdraw money from stocks in 2009, despite a 69% rally in the stock market. By late spring of 2010 that trend had just begun to reverse. Investors channeled $13 billion into U.S. mutual funds in March and almost $7 billion in early April. I started to get excited and mentioned it in my columns. But by the third week in May, the retail crowd sold almost $30 billion in stock funds and is once again on the sidelines. What happened?

The debt problems in Greece, which have since spread to the rest of Europe, are partially to blame. Skittish investors who have yet to make back the money they lost over the last two years, are afraid the global economic environment may slip into a double dip recession. That could send the markets into another death spiral.

At the same time, new revelations of wrong doing within the financial sector during and after the 2008 financial crisis has exposed the blatant manipulation and collusion among some of the biggest names in the financial business. It also turns out that Bernie Madoff was just the tip of the iceberg as allegations of fraud, pay offs and insider trading are implicating one financial big cat after another, including at least one close to the Obama Administration.

But it was the ‘flash crash’ that brought it all home to the little people.

“I had some hope that the stock market was still a somewhat level playing field,” said one client shortly after the crash, “but when I saw markets drop in a blink of the eye, I finally realized I could lose years of savings in a matter of minutes.”

It is common knowledge that high-frequency computer trading (HF trading) using complicated, instantaneous algorithms comprises 70% or more of all trading in stock markets (although the firms involved constitute only 2% of trading firms). Flash trading is a subset of HF trading that allows certain financial exchange customers to see incoming orders to buy and sell securities before the general market participants, typically 30 milliseconds in exchange for a fee. Bottom line: Wall Street insiders get the inside track as to where the market is heading.

How can that be, you say? Because there is a dark underbelly hidden behind those crisp white shirts and button down vests of certain Wall Street types. There are things called ‘dark pools’ dating back to the beginning of the decade. These are unregulated private or alternative trading systems that allow its members to transact business without displaying prices and quotes publically. Orders to buy and sell are anonymously matched and not reported to anyone, even the regulators.

What this means is that there is a whole other market beyond the prices and quotes you see running along the bottom of that CNBC television screen. None of us, not even what is called the ‘Smart Money’ and certainly not the retail investor, has any clue how much and at what price stocks are trading in this parallel market. I suspect that dark pools may have had a hand in last month’s ‘flash crash’.

Given the dwindling participation of individuals in the markets, volume throughout the last year has steadily decreased. Those who remain are largely short –term, minute by minute traders using computer driven proprietary soft ware programs to scalp a penny or two per share regardless of whether or not they are buying or selling a viable company or a dog. They have the markets largely to themselves.

That’s why the lion’s share of gains in U.S. markets is accomplished before the markets even open here. That’s why you can almost count on a major up or down move in the markets in the last half hour of trading each day. If allowed to continue, the only players left in the markets will be the manipulators and won’t that be fun watching them sabotage each other.

Posted in Investment Styles, The Retired Advisor