The surge of trading in offbeat stocks is duping inexperienced investors in to high costs and a battle with Wall Street that they cannot win, according to the founder of one of the largest trading firms in the world.
Zero-commission trading helps to build an illusion that amateur investors have never had it better, Alex Gerko, co-chief executive of London-based XTX Markets, told the Financial Times in an interview.
But the way retail brokerages sell on their customers’ orders and a “very poor benchmark” mean that the smallest investors together shell out billions of dollars in hidden costs every year when buying or selling US equities, he explained.
“The GameStop episode made it obvious that the retail part of the market is particularly broken,” Gerko said, referring to the huge spike in the console store chain’s shares in January. “The incentives are there to create a lot of churn in very illiquid stocks, which is exactly what we are seeing this year.”
On the face of it, the GameStop frenzy was an unprecedented victory of young amateur traders over Wall Street professionals including some hedge funds that had been betting against the company. But Gerko thinks the reality is the opposite. “If you think of zero commissions, on paper it sounds great — trading was expensive and now it’s free. That’s obviously complete nonsense,” he said.
Part of the allure of retail platforms such as Robinhood is that they provide zero-commission trading. But Gerko said charges are hidden in the difference between the buy and sell price, the so-called spread, meaning brokers and market makers want clients to trade shares where this gap is widest, such as in illiquid stocks that are generally thinly traded.
“If a market maker earns a certain spread from retail flow, and then pays some percentage of that spread to the retail broker . . . you end up with a perverse incentive to ensure that the end clients trade stocks with very wide spreads,” he said.
The 41-year-old mathematician’s criticism comes as shares in cinema chain AMC Entertainment and other meme stocks, popular with retail investors in online forums such as Reddit, are soaring once again. AMC shares have jumped by more than 500 per cent in the past month to last week’s highs before moderating, gaining a further boost after the company promised retail investors additional perks — including free popcorn.
Gerko said brokerages and other intermediaries are among the beneficiaries of these share price pops, particularly as retail brokers often sell their clients’ trades in bulk on to market makers, which then aim to secure favourable prices for clients. This practice, known as “payment for order flow” (PFOF), earned US brokers $2.9bn in 2020 without charging amateur investors commission up…
Read More: Retail frenzy reflects ‘broken’ US equity markets, says XTX’s Gerko