The shifting sands of US equity trading

We recently wrote about some of the trends in trading to look out for in 2021 and we touched on themes such as the growth in off-exchange trading in US equities and the resurgence in retail trading.

Evidence has now emerged which shows what can happen when these two factors combine.

Research from Themis Trading LLC has highlighted some notable developments in US equity market structure over the last week. Firstly so-called penny shares have begun to dominate the volume with a handful of companies whose shares trade at less than $1 accounting for almost 20% of total US equity market volume on consecutive days.

Now, of course, it’s not uncommon smaller cap lower-priced shares to have highly active trading days, particularly when there are stories or news flow around the stocks that can fire a traders imagination. Though it’s unusual for five or six of these stocks to be highly active simultaneously and to account for such a large percentage of the daily turnover in US equities.

Now one could argue that after last years stellar gains for many US blue-chips, equity traders are probably looking around for stocks that have been overlooked or left behind, and that may well be the case.

After all, the S&P600 small-cap index has rallied by nearly 11.0% over the last month and the Russell 3000 index by almost 10.0% over the last three months.

However, the research suggests that something else is going on here and that the upswing in small-cap volumes is being driven by retail investors.

That is the natural conclusion to draw when you realise that volumes traded by retail brokers, such as Robinhood, on alternative execution venues can exceed those executed on the NYSE and other major exchanges.

Bloomberg volume stats showed that average daily turnover in US equities last week reached 14.80 billion shares. Making the early part of January 2021 one of the busiest periods ever for US stock trading. Only three weeks in March 2020 and two weeks during the global financial crisis have been busier according to the Bloomberg statistics.

Bloomberg also found that shares within the Russell 3000 index which had a share price below $2.0 had been among the best-performing assets in 2021. Collectively rising more than 10%, compared to gains of less than 5.0% for stocks in the index priced at $20.0 or more.

Greenwich Associates estimate that 40% of US equity turnover in 2020 was executed off-exchange and the practise of payment for retail order flow which drives business to MTFs and systematic internalisers is likely to exacerbate that trend.

In Q2 2020 Robinhood earned $180 million in payment for order flow fees whilst E*Trade, now part of Morgan Stanley received $110.0 million. Two other US brokerage businesses also received more than $100.0 million each.

Competition for the order routing of US equity trades is big business, of course, the high-frequency trader’s, hedge funds and others that are buying this order flow are not altruists and they are buying the flow because they believe they can make money out of it.

Bloomberg forecast that total payments for US order flow in 2020 US will reach $2.30 billion.

That raises questions about potential conflicts of interest and best execution, but also raises concerns about overall liquidity and participation because if an ever-greater percentage of total trading volumes are executed away from the major exchanges liquidity and price discovery may suffer.

That’s an issue for the exchanges themselves and their business models but it also raises the possibility of an uneven playing field and two-tier markets. As not every participant in US equity trading has access to all of the execution venues available. Something that the authorities may wish to look at in future.