Who really moves the markets
Most trading on the stock exchange comes from large institutions and computer programs. Private investors are only a small part, and when you trade, there's usually a professional on the other side.
Learning objective: After this lesson you can judge who's really behind most of the trading on the stock market.
When you place an order, you might picture another person selling you the share. In reality the other side is usually a computer program or a large fund.
The big players
The main players on the stock market are pension funds and insurers investing huge sums for the long term, plus investment funds and ETFs, hedge funds and trading firms whose computers react in fractions of a second.
A reason for humility
That's no reason to panic, but it is one for modesty. For long term investing it doesn't matter who's on the other side. For short term trading it's decisive.
Chart reading against professionals
That's why the idea that a bit of chart reading lets you hold your own against these opponents is one of the most expensive mistakes beginners make. It's like having a kickabout with friends on Sunday and expecting to beat Real Madrid.
Measured by trading volume, institutions clearly dominate the market. A large share of volume on the big stock markets comes from computer programs. Many of them are market makers. They constantly quote a buying and a selling price and earn from the spread and from fees paid by trading venues. Whether a price rises or falls basically doesn't matter to them.
The other side
Who's on the other side decides your chances. Trading against a market maker costs you about half the spread on average. Trading against someone who knows more than you can cost far more. Experts call this adverse selection. The better informed side prefers to trade with you exactly when it suits them, and so when it doesn't suit you.
Long-term investing
For long term investments all this barely matters. You earn the risk premium by providing companies with capital and sitting through swings. You don't need to outsmart anyone for that. You're only at a disadvantage against professionals if you want to predict what happens tomorrow.
Summary
- Most trading comes from institutions and computer programs.
- In short term trading the other side is usually better equipped than you.
- In long term investing the other side doesn't matter.
Did you get it?
How do market makers make a living?
From the spread and from fees paid by trading venues. Whether prices rise or fall is secondary to them.
What does adverse selection mean in trading?
The better informed side mainly trades with you when it suits them, so tends to be at your expense.
Why doesn't the other side matter in long term investing?
Because your return comes from the risk premium and company profits, not from outsmarting others.
Check your understanding
Your task
Imagine you buy 10 shares of an ETF. Write two sentences on who the other side of the trade most likely is. Also note whether that matters if you hold for decades, and whether it matters if you plan to sell again within weeks.
Sources and further reading
- The US industry association SIFMA's market-structure data shows that retail investors account for only a small share of trading volume on US equity markets, with the large majority coming from institutional and algorithmic participants. View source ↗