Is the stock market rigged? Can the average investor get a fair shake on Wall Street? These are curious questions.
In Las Vegas, the odds are always in favor of the casino. How many times have you won a carnival game? Powerful lobbyist groups in Washington, D.C., have undue influence to sway legislation toward their economic benefit.
That’s what I think of when I hear the word rigged. Certainly, the stock market is volatile, and individual stock selection is risky, but I don’t think it is rigged.
And yet, I’m in the minority.
Most People Say The Stock Market is Rigged and an Impossible Game For Retail Investors To Win
That’s right. According to a Bankrate.com survey, 56% of people who invest in the stock market believe it is rigged against individual investors. So what do these people know that I don’t? I thought I better research and get to the bottom of this.
What follows are seven reasons an investor could believe the stock market does not work in their favor.
Insider Trading
Insider trading is trading stock based on nonpublic information. Although illegal, it happens constantly, and prosecution for insider trading is rare. Corporate elites, Wall Street executives, consultants, and government politicians have profited handsomely from information unavailable to you and me.
Armed with the foreknowledge of a famous CEO’s indiscretions and imminent dismissal, one might want to offload some shares before that information becomes public. Or perhaps knowing that a lucrative merger is in the works could lead one to invest heavily before word gets out and the price jumps.
There are endless scenarios in which one could profit if they had access to the information first. Without that information, you’d need a crystal ball to achieve the same results. That’s why the average investor is out of luck.
How often do your stock trades beat the S&P 500? Research shows that individual stock pickers do poorly, beating the market. Yet, the average inside trader has no problem beating it year after year.
Is the stock market rigged? If you’re looking in from the outside, you probably think so.
Asymmetric Access To Information
Not having access to unpublished information puts the individual stock picker at a disadvantage, but at least they still have public information…right? Yes, but your access to that information, its timeliness, and your expertise in analyzing it make a real difference.
Many people believe that individual stock trading is a zero-sum game in which one person gains and the other loses. When you invest in individual stocks, you are trading alongside a host of professional investors and big institutional investors, such as insurance companies and hedge funds.
They are focused intently on winning.
These Wall Street professionals have access to industry expertise, extensive market research, and up-to-the-minute insights you can’t afford.
They employ teams of individuals to collate and analyze that information utilizing complex computer algorithms that execute buy-sell decisions in real time.
While plenty of individual investors do well for themselves, they still suffer from the asymmetry of information and analysis available to professional institutional investors.
Is the stock market rigged? Unlike professional institutional investors who trade stocks for a living, you might not have enough information to answer that question confidently.
Access to Capital
Asymmetry of information is not the only advantage that professional institutional investors have over individual retail investors. They also have access to capital.
Institutional investors pool large sums of capital from multiple sources for investment purposes, while individual retail investors are limited to their own allocations of capital.
Institutional investors are subject to lower fees and commissions than individual retail investors. They can accomplish this through block trades.
Block Trades
Large, privately negotiated securities transactions are known as block trades. A block trade is a stock transaction of at least 10,000 shares or $200,000. That’s the minimum, but in reality, these trades are typically much larger in scale.
Block trades provide a discount to a stock exchange’s market price that is not typically available to the average individual retail investor.
Dark Pools
Block trades are often performed in dark pools. Dark pools are an alternative trading system that allows institutional investors to avoid stock exchanges and make large trades away from the public eye.
Why is this important?
These privately organized exchanges give institutional investors the advantage of lower fees and secrecy. Large public transactions can affect the price of a stock. However, the lack of transparency of a dark pool helps maintain price stability. This helps institutional investors avoid selling in the face of price devaluation and buy while prices are increasing.
Block trades and dark pools are advantages that hedge funds, financial firms, and other institutional investors receive because of their access to pooled capital. Heavily discounted fees and secretive trading opportunities that buffer against price fluctuations aren’t available to the average retail investor.
High-Frequency Trading
When discussing the stock market, it’s essential to understand that it occurs on multiple exchanges. The New York Stock Exchange (NYSE) is the largest in the world, but there’s also the NASDAQ, the American Stock Exchange (AMEX), and several other stock exchanges.
A single stock can experience price anomalies across multiple exchanges. These anomalies are profit opportunities for high-frequency traders.
High-frequency trading occurs when powerful computers with breakneck connection speeds execute large transactions in a fraction of a second. They monitor the various exchanges for price discrepancies.
For example, a stock might be trading for $5.25 on one exchange and $5.30 on another. Because of the market’s efficiency, an anomaly like that might only last for seconds before pricing equalizes across all exchanges. But these computers can recognize the difference and simultaneously buy at the lower price while selling at the higher one.
The profit might seem small. But, small profits in large quantities add up. Repeating that process frequently leads to hefty gains. High-frequency traders make billions of dollars a year.
Is the stock market rigged against individual investors? You might agree if you’re a low-frequency trader without a supercomputer that instantaneously makes you money.
Corporate Buybacks
High-earning corporate executives (the top 0.1%) receive the bulk of their compensation in stock-based pay. It’s been that way for more than thirty years. When their company’s stock does well, so do they.
Not so coincidentally, this coincided with the institution of Rule 10b-18 of the Securities Exchange Act. This rule has essentially legalized stock market manipulation by allowing companies to buy back their shares on the open market.
Instead of reinvesting profits, companies can opt to buy back stock in large quantities and artificially raise their prices. To the average individual investor, those stock gains can signal a healthy, growing company. Unfortunately, they can also be an illusion.
Corporate buybacks coupled with reductions in shares can benefit the individual investor. But when a buyback occurs without a share reduction, it’s typically only beneficial to the corporate executives at the top who are locking in their profits.
2021 was a record-setting year for corporate buybacks. A total of $881.7 billion in stock buybacks occurred in 2021. That’s up from $519.8 billion in 2020. And in the first quarter of 2022, corporate buybacks are on pace to top 1 trillion dollars for the first time.
Some analysts estimate that corporate buybacks (not actual profit growth) are responsible for 40% of the stock market’s growth over the last decade.
Can you manipulate stock prices to benefit your bottom line? I didn’t think so.
Changing The Stock Market Odds
The stock market can get overheated and over-inflated. But just as it goes up, it also comes down. Wall Street’s volatility is unpredictable and can be difficult to navigate. To make matters worse, favored institutional investors get numerous advantages unavailable to you and me.
You’ll occasionally hear a story about an individual investing in the right stock at the right time, but that is not the norm. For every one of those stories, dozens of people lose money trying to time the market with individual stock picks.
Retail investors can’t know for sure if a stock will continue rising or if a company’s annual returns will continue long-term. It is hard to know which stock to pick, how to leverage your investments effectively, and when to buy or sell.
It’s important to do what works to insulate the individual retail investor from some of these disadvantages. Some forgo individual stock picking altogether. Instead, they purchase index funds or mutual funds.
Mutual funds allow investors to buy many stocks within a single investment and spread their risk amongst that broader pool of securities. They don’t try to time the market but utilize dollar-cost averaging. And they understand the importance of diversification.
Avoiding the Stock Market Game: Investing in Other Asset Classes
Proper diversification means holding some assets outside of the stock market. And to accomplish that, many allocate a percentage of their portfolio to real estate. With fractional real estate ownership, you can passively invest in income-producing apartment buildings in high-growth markets without becoming a landlord.
Do you have a portfolio that is out of balance and heavily weighted with stocks? Do you believe getting a fair shake on Wall Street is hard? If so, maybe it’s time to consider investing in multifamily apartments.
