The Market is Rigged Against Retail Investors
The market hates retail investors. Over the past few months, “retail investors” have been getting involved in the stock market. Market analysts and talking heads on CNBC have spent the last few weeks deriding this new trend. But this hate of retail investors is not new, it’s just more obvious now.
So who are the retail investors? The retail investors are made up of a coalition between the young, lower income, and historically disenfranchised peoples. For years these same market analysts have been wondering why millennials, lower-income, and people of color have “shied away from the stock market.” But now that they are finally getting involved, the market analysts have wasted no time in deriding them. Quoted in an article on CNBC, JJ Kinahan, a chief market strategist at TD Ameritrade said: “We complained forever that the average person was not getting involved in the market. Now that the average person is getting involved, everyone is complaining about it.”
Now that more and more retail investors are getting involved, they’re discovering that the rules are stacked unfairly against them. There are a number of financial rules that apply only to people with small amounts of money in their investment account. One of the most dangerous rules is the Pattern Day Trading rule (PDT). Put simply, you cannot buy and sell the same stock on the same day more than three times a week.
This rule goes away if you have $25,000 in your account. That’s right, the rules are literally different depending on how much money is in your account. The rule is meant to discourage speculation from small retail investors in the stock market. They want to encourage people to buy and hold securities for the long term. But retail investors aren’t looking to just invest long term. For many retail investors, trading has become a way to earn extra income. With so many Americans either laid off and/or staying at home, getting involved in the market has become part hobby and part side-hustle.
The problem is that we’re dealing with historic market volatility, and retail investors are getting left holding the bag. Imagine a scenario where a recent college grad, let’s call him Joe Regular, decides to get involved in the stock market. Joe Regular goes to a broker who approves them for options trading and they deposit $500. Joe Regular has a high risk tolerance with this $500 because of the risk/reward ratio. $500 is a lot of money, but it’s not enough to pay bills, student loans, rent, etc. One good trade could double Joe Regular’s entire net worth. Joe Regular buys a single SPY call option that immediately goes up in value — increasing his portfolio to $640. Joe thinks “That’s the easiest, $140 I’ve ever made. I’m going to sell to lock this in.” So Joe sells. That’s PDT #1. The next day Joe Regular sees that the market continued to go up and that he would have made more money if he just didn’t sell. So he buys the single SPY call option again, and it immediately drops in value bringing the portfolio to $535. Joe doesn’t want to be negative, so he panics and sells. That’s PDT #2. After he sells, the market bounces on good news and continues to go up. They FOMO back into the position they just sold and watch their portfolio recover to $600. The market then has an EOD sell-off and Joe Regular watches his portfolio go down to $535 before he sells. “Heh, at least I made 35 bucks today,” he thinks to himself. He’s just made PDT #3.
The next day Joe Regular wakes up and sees that the market recovered over-night and has been holding steady at its price point for the past few hours. He buys the same call option. The market trades flat until the President tweets that he’s going to sanction China. The market gaps down. The portfolio is now worth $383. Joe Regular is stuck holding the bag. If he sells, he’ll be banned from trading for weeks for violating the PDT rule. If he’s a repeat offender, he could be banned from trading for the entire year.
Joe Regular waits until the next morning where he sees that the market has gapped down again. His portfolio is now worth $172 with two week until expiration on the option.
But Joe Regular never stood a chance. He doesn’t have the ability to trade after hours, he isn’t able to trade on the futures market, and he didn’t have the resources to properly hedge or leg into complicated gamma neutral positions like big funds can. But if Joe Regular had the same freedoms that rich people do, his risks would be much more manageable.
As technology has increased access to information via the internet, it has also increased access to markets. Financial rules need to be rewritten to treat retail investors fairly and equitably. The Pattern Day Trading rule needs to be eliminated. The intentions around this law were good; stopping people from day trading is good financial advice. But stopping people from having the ability to trade introduces incredible risk to the retail investor. There is never a scenario where being unable to sell a position is going to make your trade less risky.
I propose that retail investors march to change the pattern day trading rules. Demonstrations should be held outside the New York Stock Exchange and Federal Reserve with a bunch of angry retail investors holding huge heavy bags pumping them in the air chanting “hey hey, ho ho, I don’t want to hold these bags.” Make it a party. Retail investors, like those on the popular reddit trading community /r/wallstreetbets, could quite literally meme their way into changing the financial rules.
All I’m saying is that if there’s a protest, count me in.