Abstract
My capstone research project examines whether there is a divergence between the narrative of retail trading empowerment and the structural realities of trade execution with institutional liquidity providers and broker-dealers. The analysis explores how institutional traders extract value from less informed and capable retail traders, the system of incentives that institutional traders face, and the impacts of algorithmically enabled retail traders on this opaque system. Data will be gathered from SEC 606(a) reporting from various order routers. This data contains the volume and percentages of trades that are routed to specific liquidity providers along with the amount that the liquidity providers pay per order. Furthermore, I will be analyzing the different brokerages through different, well-known lenses noted by the characteristics of individuals who trade on each platform. Some will be buy-and-hold brokerages, where individuals aren’t necessarily daytrading, but investing like a normal person should. Others will be noted as daytrader heavy due to their advertising and integrations with popular daytrading technology. One other will be labelled as primarily algorithmic retail traders due to its API-first interface, providing insight into the technological democratization of programming. Quantitative analysis will include the value of the routing that liquidity providers place on each brokerage through the per-share payment received by each broker dealer for both stocks and options. Through this data, I will examine the value of trades routed from each broker-dealer. The human and social dimensions here are complex: retail traders are oftentimes uninformed or even misinformed at times on two levels: opacity in order routing systems and the vested effort by certain entities and personalities in presenting daytrading as a way to get rich quick. For many broker dealers, especially those who are fully invested in being a broker-dealer, their users are not their clients; the liquidity providers are. Liquidity providers are paying for the opportunity to make money off of institutional grade information.
I plan on applying the theory of Algorithmic Power, as stated by Pasquale in 2015 in The Black Box Society. This refers to the black box of intertwined algorithms that govern many day to day aspects of our society, including Google’s pagerank, social media algorithms, and trading algorithms that more or less dictate the status of the economy. Also, Langdon Winner’s Politics of Artifacts framework will be used to frame the opaque nature of the payment for order flow system as political and meaningful beyond just an economic system for trade execution. Further document analysis includes liquidity providers’ publishings, especially their discussions of retail trading and documents regarding legal issues that some of these liquidity providers have faced. These liquidity providers will be present in the underlying 606(a) data for entity-contained analysis and efficacy. Findings included the fact that certain companies are somewhat overtly misrepresenting themselves to their users, and that they make money off of their users placing poor trades. Also, a system that under regulates opaque entities and systems and frequently forgives everyone except the public traders was observed through the data and framework analysis. Implications for this analysis include the finding of an imperative to inform those fooled by the algorithms and people of the inner workings of the systems on which they trade, along with providing insight into those inner workings in a clearer manner.
