The COVID-19 pandemic has upended the economy and the global way of life. As Jack Plotkin, former Goldman Sachs employee says, this has had unexpected effects on the stock market, effects that have contributed to trends that were not easily predictable. For example, a global economic crisis is usually expected to translate into a bear market on the stock exchange. While this was the case at the outset of the pandemic, the market has reversed course sharply and has surged since April, now claiming new all-time highs.
Another unexpected, but perhaps related trend, has been the rise of day trading among non-institutional investors. Jack Plotkin, a seasoned expert on the subject, who spent nearly a decade at Goldman Sachs as an investment banker and financial strategist, elaborates on the causes behind the rise of day trading and where it is likely to lead.
“We are seeing millions of Americans suddenly without a job, underemployed, or furloughed. Economic activity has slowed down. Entire industries are at a standstill,” says Jack Plotkin. “Does this sound like an environment conducive to day trading? Absolutely not. Yet, day trading has never been bigger. You want to know why? Well, you’ve got millions of people essentially being subsidized by the government with boosted unemployment benefits and payroll protection loans. At the same time, people are landlocked with shelter-in-place directives. They’re not going out to bars, restaurants, movies, and gyms. With money flowing and less to spend it on, they’re letting it ride on the stock market.”
The beginning of day trading.
As the stock market continues trending up from its March lows, daily market volumes have grown as well and have been much larger than expected. While this is the opposite of what usually occurs during a time of economic crisis, Jack Plotkin points out that we are living in a unique moment in history. “There is now a large group of younger, technologically savvy people with additional free time and unprecedented access to easy-to-use, commission-free trading platforms like Robinhood,” explains Jack Plotkin. “It’s hard to gamble on sports right now, hard to get to a casino, but the market is open every weekday and, when it’s closed, you can still trade pre-market and after-market. Most importantly, unlike traditional casino games, there is no edge to the house – there is no house. While the stock market has a huge element of chance, it is ultimately not a game of chance. Analysis matters.”
Jack Plotkin notes that day traders have been around for as long as the stock exchanges. However, those performing the task of day trading were almost exclusively highly specialized dealers. Furthermore, market conditions were made to suit the classical type of buy-and-hold investors, rather than investors who might buy and sell repeatedly on the same day. Before 1975, the commission for every trade on the exchange was fixed at 1%, which meant that an investor would have to make over 2% on the stock to have any real gain. That was obviously hugely discouraging for day traders.
Then, a 1975 decision made by the Securities & Exchange Commission to ban fixed commissions gave rise to discount brokers and subsequently day trading. Other technological improvements, such as electronic trading platforms and quicker trade settlements, were also important factors that led to the invention of market-making, a form of institutionalized day trading.
“When I started at Goldman Sachs, commission-free trading didn’t exist as a concept,” says Jack Plotkin. “If you were a massive institutional investor moving millions of dollars a day you could minimize your trade costs, but this was not something generally available to Joe Trader sitting at home in a small town in rural America, trading via the internet.”
Robinhood launched in 2015 and reached 3 million users by 2018. By the end of 2019, Jack Plotkin points out, it had 10 million registered customers and was strong enough to force established brokers such as E-Trade, TD Ameritrade and Charles Schwab to embrace the commission-free model. Since the start of the pandemic, Robinhood has added another 3 million accounts with the reported median age of its customer base right around 30 years old.
Jack Plotkin on where we’re going from here.
In addition to the many changes that this year has brought to everyday lives, the investing landscape is yet another one that has been altered significantly. And whether that is good or bad remains to be seen. “Arguably, the elimination of trading costs is beneficial because, in theory, it evens the playing field by enabling a broader number of investors to participate in the markets,” says Jack Plotkin. “On the other hand, if data about retail investors’ patterns are being shared with institutions in real-time, they can essentially use that data to front-run the market. So, from an oversight perspective, we have to be careful that everyone has access to the same sources of information to ensure it is a truly level playing field.”
However, many in the traditional investment community has been very critical of the day trading boom as well as the new class of investors. Some renowned institutional investors are accusing the “Robinhooders” of inflating prices by neglecting fundamental analysis. Others are comparing today’s market to the dot com bubble in the late-90s and warning the less experienced participants of potentially severe consequences that could come along with a sudden market meltdown. They are especially critical of the practice of some traders of investing in bankrupt or severely debilitated companies while looking for a bargain, and in turn, inflating their price much beyond any reasonably imputed value.
“These young guns who are jumping onto Robinhood and chasing the latest biotech news story are in for a rude awakening,” says Jack Plotkin. “Markets are cyclical and mean-reverting – they may come unhinged from fundamentals in the short term but in the medium to long term, gravity reasserts itself with a vengeance. Without proper hedging and diversification, these new retail investors are setting themselves up for massive losses. My fear is that when it comes it will wipe out a lot of people at the worst possible time – when the government’s COVID-19 benefits have ended but before the economy has recovered. So, I advise caution. Remember: when you’re running with the herd, you generally don’t see the cliff until you’re already in mid-air.”