Once upon a time, trading was pursued by retail investors as a means to wealth creation (or, at least, enhanced retirement savings). Today, it seems for many, more a form of recreation and entertainment. This transition has consequences: (1) it may lead to excessive and wasteful trading, in which retail traders systematically lose; (2) it confuses and delays price discovery, as uninformed traders band together to resist inevitable price changes; and (3) it may discourage other retail investors from viewing the stock market as a safe place in which to invest retirement savings.
But this transition did not occur accidentally. In overview, the pattern was predictable: New entrants into the brokerage industry found their path blocked by established discount brokers (for example, Charles Schwab), who dominated discount brokerage. To compete, they had to innovate—and they did. Led by Robinhood Markets, Inc., they developed zero-commission brokerage. This depended upon the willingness of high frequency traders (also known as “wholesale dealers,” such as Citadel Securities or VIRTU Financial), to buy their order flow through a technique known as “payments for order flow”). These “wholesale dealers” were delighted to buy the uninformed trading of retail investors, which carried no threat that these investors had informational advantages. It was a “no-brainer,” and the resulting linkage between high frequency traders and retail traders quickly revolutionized the industry—for better or worse.
