One of the most significant but least talked-about developments in American life over the past decade has been our shifting relationship with the stock market. In the past 10 years, as the market has moved on a virtual non-stop upward trajectory to all-time highs, we have seen some hugely important changes that forever changed the landscape of investing. Here’s what they are, and how we can fix them before it’s too late.
Cheap, Easy, and Accessible
First is the elimination of trading fees. Previously, anyone who wanted to buy or sell a stock had to pay a commission fee for that transaction. Those fees were sometimes $20 per trade, or $40 to make a purchase and subsequent sale of a particular stock. Even when brokerages reduced those fees to $5 each, they acted as something of a caution sign for investors before jumping into a trade. However, 2019 saw the end of most trading fees, essentially letting users into the market without any cost besides what they had to pay for the stock.
While some may see the fee as an inconsequential amount, those buy-and-sell fees represent 1% for a hypothetical investor looking to trade $1000. And for day traders – those who frequently buy a sock only to sell it shortly thereafter – those fees could reach hundreds or thousands of dollars per year. Suddenly, the market became that much more accessible.
In addition, stock trading apps like Webull and Robinhood have made stock trading simpler than ever. With a quick signup and deposit, anyone with a smartphone can begin trading stocks with thousands of other people around the world. Further, chat rooms that cater to investors have popped up online and through app stores, creating communities where investors can share ideas and strategies with each other.
Of course, it doesn’t hurt that the Federal Reserve has pumped literally trillions of dollars of liquidity into the markets to help ensure that stock prices will continue to rise. Many Americans have benefitted from this, especially those with large investment or retirement accounts. Any average trader would have had a good chance of making money in this market as well, since all three major indexes have a better-than 10% average annual return since 2010.
Taken together, the increased ease and access, along with reduced cost structure and communication among traders, have opened the stock market to millions more people. No longer just the playground of the wealthy and elite, exchanges are now accessible around-the-clock with a few hundred dollars to invest and a wi-fi connection.
How Machines Rule the Trading World
That brings me to another critical point – the issue of how trading is conducted. Decades ago, trades could only be done by phone. People had to call in an order that could take minutes or hours to process. There was no such thing as trades that took milliseconds to complete. Today, the markets use not only ultra high-speed connections, but also computer algorithms that conduct a large percentage of the trading. By some estimates, 70-80% of trading happens through these automated methods. In essence, computers are running the market while humans try to calculate what they will do next.
These “algos” can often shift money in one direction or another, and many see this as manipulation of the market. For example, if an algo drops the price of a stock by several percent through a few small trades, it might cause human investors (and even some other programmed computers) to grow alarmed and sell more shares of the company, creating a cascade effect. Ultimately, the share price gets dropped artificially, and someone or some fund can benefit by purchasing those shares for much less than they were just a few minutes before.
And we are talking about enormous sums of money. The collective market cap of the companies listed in the S&P is well in excess of $30 trillion. In a typical day, NASDAQ reports a total of 200-300 billion trades totaling between $5-10 trillion. That means that every few days, the market churns as much capital as the United States GDP.
To some extent, we should not be surprised that this confluence of events has led to a market that is, frankly, out of control. Recently, much has been written about the chaos caused by retail investors seemingly banding together to drive up the share price of a few stocks, at the expense of certain institutional investors who were betting against those stocks. The beneficiaries of note? GameStop (GME) and AMC Theaters (AMC).
When massive, unexpected moves happened in those stocks and created devastating losses for certain funds, Wall Street was shaken by the system they had created. News outlets started addressing the issue, but they were all missing the point. To her credit, Representative Cortez grasped the situation, tweeting that after years of treating the stock market as a casino, institutions were now pouting to see others benefit by playing the same sordid game.
Is There A Solution?
I propose that there is an answer, one that could be implemented quickly and would have minimal impact on so-called retail investors. The Biden administration has floated the idea of taxing unrealized stock market gains – comparable perhaps to paying property taxes based on the estimated value of your home rather than what you paid for it. However, this idea is awful, one that would discourage new money from entering the market.
The stock market should not be an opaque world where average people are either too afraid or too ill-informed to invest their money. There are, after all, great returns to be made by allocating reasonable amounts to market funds. This kind of capital tax will prohibit investment, which should the opposite of what we want.
A much simpler and more effective strategy would be to tax individual trades at one penny each. For someone who makes 100 trades in a calendar year, the price will be $1, no more or less.
But for a computer that makes millions or even billions of trades a year, the price will be prohibitive. At the current trading rates, the taxes raised on 200 billion trades would be $2 billion. That’s for one day of trading, and there are over 200 trading days per year.
The likely consequence of such a tax is that algorithmic trading would shut down, or at least abate. True price discovery could take place for many stocks that have either been held down or propped up in price for years. Retail investors could feel more comfortable knowing that stock prices are less likely to spiral out of hand due to computer trading. And the cost to an average investor would be negligible.
Whether this solution will see the light of day remains to be seen, but I stand by the notion that major changes need to be made to the way we conduct our markets. For anyone who believes that government should leave the markets unregulated, I’m guessing you have either been rewarded greatly by the current system, or you have not touched the market yourself. In either case, please know that millions of others would benefit from fundamental market changes.
Without some kind of intervention, the market will only grow more chaotic while retail investors suffer the consequences.