The brokerage industry today is on a wave of serious changes and this is no longer just a beautiful metaphor, but a reality that is woven into the lives of people far from financial markets. If only yesterday the terms "broker" and "stock exchange" evoked a stable association with people in black jackets and ties, today it is not only "millennials" (people born between 1981 and 1996), but also representatives of "generation Z" , who is now a little over twenty years old) master the financial markets. And they not only master, but also beat the Wall Street professionals at their own game. How is this possible?
We will talk about this in today's article.
The stock market has long been the lot of the "middle class" even in the USA, where it was born. In Russia, for example, the penetration rate of financial services is much lower, and any sales person from a brokerage company knows by heart the selling script that "in the United States, every housewife owns shares." In reality, this is not entirely true: a few years ago, the threshold for entering the American stock market was about 10 thousand US dollars, which not every housewife could afford.
In other words, the ability to buy shares of well-known companies was available to a solvent citizen who has not only a permanent job, but also savings. If we talk about professional speculative derivatives (futures, options, etc.), then the entry threshold there was even higher due to the high cost of the instruments themselves.
Until the 2000s, the interaction between the client and the broker took place over the phone. You probably remember the shots from the movie "The Wolf of Wall Street", which showed the full degree of cynicism of brokers and insecurity of ordinary clients far from the financial market. Further, communications began to be carried out via the Internet and trading terminals (programs for sending applications). The development of technologies has lowered the threshold for entering financial markets: high-speed Internet and increased server performance allowed brokers to process a huge number of small client orders in a split second, and remote opening of client accounts made it easier to connect new clients to trading systems. How did this affect the financial market?
"Smart money" versus "conventional"
According to Dow Theory, which formulated the principles of technical analysis more than 100 years ago, the cause of large price trends is the action of informed players with expertise and access to analytical resources. Such players are called "smart money", or "smart money", and previously they were associated with hedge funds and active managers who know how to find an "alpha" (advantage) in the market. An example of such a fund is the fictional company Ax Capital from the famous TV series Billions.
Shot from the movie "The Wolf of Wall Street" (Source: Pinterest.ru)
The hedge fund industry grew in popularity at the end of the 20th century, with Ivy League graduates eager to work for one of these funds and become part of the smart money. In fact, the performance of “smart money” is not at all as high as it is commonly believed (most active managers lose at all the returns of the stock index over a long distance). However, observations show that emotional decisions and reactions to news are more inherent in private investors, while “smart money” builds their strategies more often based on fundamental assessments. This is evidenced by research on "market sentiment" conducted by CNN.com. Mass interest in assets from the majority of market participants is observed near market peaks.
Source: nn.com
There are, of course, exceptions to this rule. For example, recently it became known that the Japanese "Softbank" was buying options on stock market instruments in unprecedented large volumes at the end of August 2020, just before the fall, and this is not the first example of this player's behavior: in December 2017, he took a large position in bitcoin right before its fall and recorded a loss of $ 160 million in the winter of 2018. Therefore, magnitude does not necessarily provide a glimpse into the future.
However, the size of the player can influence the short-term behavior of the price, accelerating its movement. What if small players come together and focus their efforts in one direction? In this case, we can say that they are beginning to influence the market. A striking example of this influence is the collective investment instruments, which I will discuss below.
Avalanche "ETF"
The liberalization of financial markets began with the emergence of “collective investment” instruments. At first these were "mutual funds" (Mutual funds), but they were and still are available only to US citizens. A revolution that no one noticed was the emergence of the so-called "exchange traded funds" or "exchange traded funds" (ETF). Their essence is quite simple: by acquiring a share of such a fund on the stock exchange for several hundred dollars, a private investor gets the opportunity to follow the return of the stock index or repeat any strategy that the fund manager implements (for example, investing in bonds or the commodity market). The funds of the fund's shareholders are pooled together and form a single pool, which is already invested in securities.
The most famous ETF, called SPY (also called a "spider"), follows the performance of the S & P500 (the most famous US stock index) and was launched in 1996. Today, his net assets are over $ 300 billion.
Growth of assets under the management of the SPY fund (Source: ycharts.com)
As you understand, the investors of the SPY fund do not belong to the cohort of professionals, but consist of private investors, the very "retail". The cost of SPY on the exchange is $ 348 at the time of this writing, that is, the threshold for entering the market has dropped so much that investment has become available to almost anyone.
Index ETFs have a history dating back to the early nineties, but they've really grown in popularity over the past few years. The reason is simple: US stock indices have been growing steadily over the past five years without prolonged corrections.
The rise of the S & P500 stock index (Source: macrotrends.net)
The outflow and inflow of funds in ETFs is already a significant force today that can move stock prices in one direction or another.
If you've watched the movie Big Short, you remember one of the key characters, Dr. Michael Burri, who predicted the 2008 global financial crisis. At the end of 2019, he gave an interview to Bloomberg, in which he said that he sees a bubble in the ETF market, which can have serious consequences for the market.
The reason for this was a precedent: in 2019, the volume of funds invested through “passive strategies” for the first time exceeded the volume of “actively managed funds”. Not all passive strategies are ETF-driven, but the fact remains. “Smart money” is losing ground, and this trend is likely to continue. Millennials are beating baby boomers in their own field.
According to Dr. Burri, there are two potentially dangerous consequences from this process: firstly, the strengthening of "passive" strategies (and following the index is called a "passive strategy") leads to a spontaneous increase in the prices of stocks that are included in the stock index: no ETF investor cares about the quality of business of the companies whose shares are included in the index. They just buy them "because the indices are going up," triggering a self-fulfilling prophecy. We see this well today, observing the unrestrained growth of shares of Apple, Microsoft and Amazon (they make up from 15% to 30% of the share of index ETFs). Money is not invested in them today, but is parked. This is caused, of course, not only by ETF investors, but they are contributing their fair share to this process.
Tech stocks rise (Source: Tradingview.com)
The second possible consequence is the intensification of the collapse in stock prices at the time of the mass exodus of investors from the ETF. This is possible, since the investment discipline of “retail” remains strong only while the indices are growing.
The Robinhood Revolution
The second interesting trend does not even apply to millennials, but to the “generation Z”, which lives in social networks, instant messengers and mobile applications.
Launched in 2014, the acclaimed US mobile Robinhood app has gained enormous popularity over the past few years, especially among young people. The ideology of the application is the absence of commissions and a certain rebellious spirit of opposing the new to the old. The "old world" in this context is represented by boring people in jackets, broadcasting outdated values, and the "new world" - by the people of the Internet and social networks. Marketers have been exploiting this conflict for a long time: Apple, for example, once released an ad representing IBM as a totalitarian Orwellian "big brother." Today the old world is beginning to lose ground in the brokerage business.
The absence of commissions in the Robinhood app was explained by the large reach of the app's audience and the ability to earn money on premium subscriptions (for $ 5 per month, you can get access to margin trading and other options).
Source: robinhood.com
In reality, the application makes money on something completely different, namely, by reselling the flow of client orders to large financial companies. This is a particular subject of regulatory scrutiny, but that's a topic for a very different article.
Robinhood users, as befits a generation of social networks, are not at all disunited, but are quite controlled by bloggers from Youtube, Twitter, TikTok and leading private channels in Slack, Telegram and other messengers. The presenters of the respective channels do not have a CFA degree and other financial market regalia, but simply express their opinion in the online stands, and the one who sounds confident and speaks the same language with the public looks the most convincing of all.
For example, the philosophy “Stocks only go up” is actively promoted by one of the top market bloggers, Dave Portnoy, who is currently followed by almost 2 million subscribers. Many try to do the same.
Source: Twitter.com
According to Robintrack.net, Robinhood users during the 2020 stock market crash caused by the coronavirus pandemic behaved almost like a single fund that buys stocks that have fallen in price, causing their price to rise: they were interested not only in the stocks of tech giants, but also in companies. preparing for bankruptcy (Hertz, JC Penny, etc.). Airline stocks that were losing heavily were also targeted by Robinhood traders.
In the darkest days for these companies, a wave of purchases suddenly appeared from nowhere, and their shares soared, which seemed unthinkable. For example, in early June, there was a stir around Hertz shares. According to unofficial data, the wave of purchases was launched by users of the mobile application. The buyers simply did not know that the company was planning bankruptcy. Most likely, there was no issue about her on TikTok that day.
Hertz Stock Price Chart (Source: tradingview.com)
From the point of view of the big picture, the rise of the stock looks like an insignificant notch on the chart, but at the moment this rise was more than 400% and led to the triggering of stop orders of other market participants (who were playing for a fall ).
Thus, the cascading effects provoked by users of mobile applications today more and more clearly affect the prices of little liquid stocks and other financial instruments. This influence is growing as the mobile audience grows.
If you look at the logic of decision-making by Robinhood users using Robintrack.net, it becomes clear that they are buying the same set of technology stocks (Apple, Microsoft, Amazon) and shares worth about $ 10. Why $ 10? Because they are cheaper.
Robinhood App User Popularity Leaderboard (Source: Robintrack.net)
The Robinhood phenomenon has not gone unnoticed by the fintech industry, and today there are many startups offering users mobile trading applications. Every broker strives to have an accessible mobile application, seeing this as a growing user trend.
conclusions
What is called the modern word "disruption" (translated as "disruption", "disruption" or "disruption of the established order of things") has reached the financial markets, which were previously the privilege of "white collars". The influence of the social factor on economic processes, and in particular on the exchange markets, is increasing today: the development of technology accelerates this process. The development of 5G networks and ubiquitous market access through mobile applications will strengthen the position of a new generation of traders.
Several years ago, discussions around technology in trading focused mainly on the high-frequency trading industry and the possible negative impact of trading algorithms on price behavior. But we see that technology in financial markets is not only about algorithms, artificial intelligence and machine learning. It's also about social technology. In the word “fintech”, the root “tech” is increasingly influencing what is happening, and possible negative influences are balanced by the benefits that ordinary users get from having access to tools and strategies that were previously available only to “smart money”.
And today it is already clearly seen that the future belongs to financial companies with strong technological expertise - those who can ride this “perfect storm”.