Growing Influence of Retail Traders in Stock Markets

As much as 2020 will be defined by the Covid-19 crisis that resulted in untold miseries on populations across the world, 2020 will also be remembered as a strange year when stock markets across the world witnessed huge gains despite lock-downs and limited economic activity in most countries. A lot has already been written about the probable reasons behind the surge in stock markets- money printing and super low interest rates by central banks and increase in savings due to reduction in discretionary expenses on vacations, entertainment and going out in general. I will highly recommend this excellent New York Times piece (Why Markets Boomed in a Year of Human Misery ) to dig further into these causes.

Apart from the usual explanations of increase in money supply, another phenomenon that increased volatility surge in the markets (or at least some stocks) is the increase of retail traders (or investors, whatever is your philosophical inclination). This trend is much broader than the current GameStop and Reddit saga that is making headlines across the world. As per media reports, approximately 10 million new demat accounts were opened in India in 2020 alone. A majority of these new accounts are opened by young retail traders from tier 2, 3 cities. India has close to 50 million demat accounts, so 20% new accounts were opened only in the last year. Here are some of the reasons behind the sharp increase of retail traders in India and beyond.

Rise of fintechs and discount brokers like Zerodha, Paytm Money, Groww, 5paisa that have sharply reduced brokerage charges and made trading extremely easy with intuitive user interface in their applications.
Democratization of stock trading expertise. For a long time, it was assumed that professionals have the best knowledge in their respective fields. Independent creatives reaching their audiences through OTT platforms, rise of social media influencers, authors reaching to readers without big name publishers are all a part of this broad trend of amateurs competing against professionals. Stock markets are no different when a community of retail traders on Reddit (mostly comprising of students, young professionals, laid off workers) “short squeeze” large hedge funds and creating an environment whose impact will be much broader than the GameStop price. If you need, more in-depth understanding of this GameStop story, suggest you read this excellent article.
Due to covid restrictions, many people have been working from home. Stock trading has become a pursuit to ward off boredom. With super low interest rates and stagnant real estate sector, stock markets are becoming the asset of choice for putting in savings.

Many argue that even though the number of retail traders have increased, their trading value is minuscule compared to the large financial institutions. As per a Citadel Securities report, retail traders account for 20-25% of stock market’s activity, up from 10% in 2019. It’s tough to argue against the impact that retail traders are having in stock markets.

Next comes the big question, if this increase in retail traders is temporary or a more permanent shift. While prediction is a futile business as taught by 2020, I will take my bets on the more permanent shift. If we closely think about the above reasons for increase in retail trading, most of the reasons like rise of discount brokers, expertise no longer limited to large funds and remote working are all fundamental shifts that have very little to do with how quickly we get over the covid health crisis.

However, the real test of sustainability of retail trading will come from a stock market crash. It’s always fun to trade when winning money but staying in the game when losing money is a different ball game. It has been widely observed that retail traders are the last in a bull market and hence lost the most in a market crash. A market crash (or at least a deep correction) looks likely given the overheated stock markets in most countries but even here there are reasons to be optimistic.

“More money is lost in waiting for the correction than in the correction itself.”

General economic activity in most large economies are getting concentrated with few large organized players. In fact, covid has only accentuated this trend with 2-3 large companies capturing most of the value in an industry segment. Aggregators and e-commerce companies have further consolidated markets even in the most fragmented local markets. This market consolidation is getting reflected in higher stock prices for leading companies, resulting in longer bull markets.

Another trend of the last decade was increase in high frequency algorithmic trading. As per most estimates, proportion of algorithmic trading is 65-70% in US (higher than 80% in Forex markets) while around 50% in Indian markets. This has increased volatility in stock markets which gives good traders opportunity to make money. In fact, the returns by most Mutual Funds run by professionals have struggled to beat broader market index returns and hence lures retail traders to get directly in the game.

Even with new trends and changes emerging in stock markets, the fundamentals of making and losing money don’t change. As written by Jesse Livermore (considered to be the greatest trader of all time) 100 years back.

“Wall Street never changes, the pockets change, the players change, the stocks change, but Wall Street never changes, because human nature never changes.”