- Jun 6, 2007
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The abundant of responsible analysts were right on the driving up of stock prices on select stocks generated by social media spin that it was not going to end well for many small investors who got caught up in the social media hype and invested and took a huge financial loss in the process. One example is Gamestop stock that on January 29th was trading at $325 per share and today traded below $97.5 per share incurring an over 70% (seventy percent) loss in value. The state of the brokerage industry as it stands today really calls for some good regulation that will help protect small investors and will bring fairness into the system as with much good regulation many of the people being helped aren't going to like the result even though it is best for them; policy makers in Washington have to ignore this and do what is best for them and for the country. This problem stems from the situation that occurred around a year or two ago when the brokerage industry went commission free for stock trades meaning that when individual stock investors purchased or sold a stock they did not have to pay any fee or commission to the brokerage because it goes back to the old adage that nothing "of consequence" is free in this world you pay one way or the other. Because brokerages no longer get these commissions the way they make their money is they sell the order flow of their customers trades to financial institutions that are market makers (financial institutions that take the other side of the trade for investors so the trade will go through in a timely fashion) and what the brokerages get is rebates per trade (instead of commissions). The glitch for small investors is these market makers are high speed algorithmic traders and what these software controlled market makers do is clip the transaction price so the small investor loses a minute amount on the transaction price but for the market makers that buy and sell billions of shares of stock over a year the minute amount on each share transacted ends up amounting to large amounts of money during this period. For example, let us say small investor Joe wants to sell a 100 shares of X Corporation shares where the market price is around a $100.00 per share and the normal offer/bid unfolding on an exchange would culminate in a bid of $99.99 per share being accepted well what the high speed algorithmic traders do is they study millions and millions of transaction and realize that the normal offer/bid process will culminate in this exchange price so what they do is bid something a little lower like $99.94 and process the trade to an outside observer of the market that looks like a fair transaction price but to an expert it wasn't the optimal price! To these brokerages that act as their own market makers they do this same thing to small investors but instead of an outside entity clipping the investor it is an inhouse entity clipping that investor!
To address these outlined problems regulators should do the following. The brokerage industry should have a minimum commission fee they have to charge, the Security and Exchange Commission should get from brokerages their direct cost structure and the number of transactions they process and determine for the industry the cost per transaction and make that the minimum commission and update that every five years. For partial share transactions, brokerages can reduce the commission pro rata. The benefit of a minimum commission for small investors is that it would deter them from jumping in and out of individual stocks, the stock market is not for gambling which a significant number of these small investors are turning it into with their trading behavior based on what direction the wind is blowing on social media because over the long-term the social media alerts are not accurate enough to protect small investors from getting financially hurt. The second major area of regulation is on brokerages, regulators have to stop the clipping of small investors to do this there has to be a mandate on brokerages that at least half their order flow has to be directed to trading venues where the entity conducting the trading has no pecuniary interest both direct and indirect in the transaction price that ultimately takes place for that order and the brokerage has to have a formula for the selection of such diverted orders that is non-specific meaning there is no second class investor all investors are treated the same the selection process is completely random it is a fair system.
To address these outlined problems regulators should do the following. The brokerage industry should have a minimum commission fee they have to charge, the Security and Exchange Commission should get from brokerages their direct cost structure and the number of transactions they process and determine for the industry the cost per transaction and make that the minimum commission and update that every five years. For partial share transactions, brokerages can reduce the commission pro rata. The benefit of a minimum commission for small investors is that it would deter them from jumping in and out of individual stocks, the stock market is not for gambling which a significant number of these small investors are turning it into with their trading behavior based on what direction the wind is blowing on social media because over the long-term the social media alerts are not accurate enough to protect small investors from getting financially hurt. The second major area of regulation is on brokerages, regulators have to stop the clipping of small investors to do this there has to be a mandate on brokerages that at least half their order flow has to be directed to trading venues where the entity conducting the trading has no pecuniary interest both direct and indirect in the transaction price that ultimately takes place for that order and the brokerage has to have a formula for the selection of such diverted orders that is non-specific meaning there is no second class investor all investors are treated the same the selection process is completely random it is a fair system.
