Trading meme stocks like GameStop can mean billions in hidden costs for retail investors - reflecting how the equities market is broken in places, a markets chief says
- Surging trade in GameStop reflects a broken part of the equities market, Alex Gerko told the FT.
- The allure of commission-free trades won't end well for retail traders betting against Wall Street, he said.
- "I can assure you in the long run it won't be retail participants winning this game," he said.
The retail trading frenzy that saw groups of amateur traders encourage one another on Reddit to buy and hold meme stocks is the product of zero-commission trading, according to the co-chief executive of a London-based trading firm.
Apps like Robinhood that offer commission-free trades on stocks have created the impression that retail traders place wagers against the broader stock market and make money in the process. But the boom in meme-stock trading is an example of a battle against Wall Street that small traders cannot win, Alex Gerko of XTX Markets told the Financial Times in an interview.
That's because trading apps use a practice that makes inexperienced investors together spend billions of dollars in hidden costs when buying or selling stocks, he said. Brokerages direct stock orders to third-party market makers for execution, in exchange for compensation known as "payment for order flow." This does not necessarily secure the best price for an order.
"The GameStop episode made it obvious that the retail part of the market is particularly broken," Gerko told the FT about the video-game retailer's surging 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."
In an effort to beat Wall Street at its own game, Reddit traders banded together to ignite GameStop's share price, which led to almost unprecedented volatility. The company's surging stock delivered a rare victory to small retail traders and a crushing defeat to some of the hedge funds and prominent traders that had bet against it.
But Gerko doesn't consider the fiasco as a win for Reddit traders. "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.
Charges for trading are buried in the difference between the buy and sell price, or the so-called spread, that market makers are willing to commit to. Brokers and Wall Street trading firms want to trade shares where this gap is the widest, especially for stocks where there are only a handful of buyers and sellers and volumes are low.
US brokers earned nearly $3 billion in 2020 through payment for order flow operations without charging upfront commission, according to the FT. "So where does this money come from? The retail investors," Gerko said.
This practice is banned in the UK and Canada for example.
Gerko suggested one solution would be for the US to strip out the process for its brokerages too, and instead provide the orders to exchanges where they would match off against each other, or trading firms would compete for execution.
But even with those changes, he doubts retail traders can triumph from another battle against Wall Street.
"Retail investors have managed to cause some pain to one hedge fund," he said. "I can assure you in the long run, it won't be retail participants winning this game, that's just impossible."