The Crushed Dream of A Democratized Stock Market.

I have a ridiculously naive hope that one day we will return to a Stockmarket where individual investors fund their retirement and kid’s education by actually researching the fundamentals of a company.

People used to to do this. Warren Buffet did it spectacularly well, but thousands did the same thing on a much smaller scale, researching the stocks of companies that made products that they liked.

That is such a ridiculously naive hope. The reality today is that 75% of stock market trades are done by computers in what is known as High Frequency Trading. The algorithms look at things like words in a speech by Bernanke and sentiment expressed by day traders on Twitter.

The 25% of trading done by humans is mostly done by Hedge Funds which means that investors pay 2 and 20 (2% of funds under management and 20% of the capital gains aka profit) for the privilege of human judgement.

I don’t think that “social trading” is the answer. What we need is more like “social investing”. It sounds the same, the only difference is the time horizon. The difference is not just one of degree, it is one of kind. Investing is a fundamentally different game from trading.

Google “social trading” and you see a vibrant “space” (VC speak for a market), with lots of ventures raising money and “getting traction” (VC speak for something that precedes revenues and profits). StockTwits, SeekingAlpha and Covestor and others look like they are onto something big.

I don’t think so, not yet, not quite. Many of these sites encourage you to trade, so they will be acquired by online brokerage firms, so returns to VCs maybe OK.

OK, but not great. After liquidation preferences, returns may not be good for entrepreneurs. For great returns for all, the humble individual investor (aka consumer) has to do great and be seen to be doing great.

We need the equivalent of online stock trading in the 1990s. That was disruptive. However, I don’t think the next disruption will be in trading. It will be in investing.

Google “social investing”; it refers to investing with a social aka philanthropic objective. That is good, but it is a sideline activity for people who are already wealthy. There is nothing about millions of retail investors building financial security by learning from each other how to invest patiently in shares of companies.

High Speed Equities Trading by humans is a losing game because it is all about speed and computers are better than humans at speed. You can feel the rage of the day traders who get side swiped by the machines when you go on these social trading sites.

Investing, getting to know a company and buying shares with an expectation of a return some years later, has moved to private markets, to private equity (from VC to LBO). That is where the old fashioned analysis of company fundamentals takes place and that is where the money is being made.

Private equity markets are becoming more like public equity markets, with various secondary markets for investors to buy and sell private company stock.

In ye olden days, those companies would have gone public, so there would be no need for “public-lite” secondary markets. Thanks to small cap hell (institutions don’t want to trade illiquid small cap stocks), the bar to go public has been raised to a much higher level.

This opens up a big window of opportunity. Today we have a well-regulated public market with small cap stocks trading in a very inefficient way (i.e. offering great opportunities to investors) just at the same time when XBRL is making it possible for retail investors to easily crunch the data without help from any Wall Street intermediaries.

Wall Street does not care about these thinly traded small cap stocks, so these early adopter tech-enabled retail investors will have a “field day”.

When this will happen I don’t know. There is a big difference between imminent and inevitable. When it does happen, it will help reduce inequality and promote financial inclusion. So I hope that it will happen.

As to how it will happen, my guess is that patient investing in individual publicly listed stocks will return via High Net Worth (HNW) individuals and even Ultra HNW individuals (working through their Family Offices). Wealthy investors have the greatest need as well as the capability to act. They have a great need because just buying low cost index funds is not the answer and paying 2 and 20 and suffering from lock-ups makes the “alternative” world of Hedge Funds and Private Equity challenging as well.Wealthy investors clearly have the fire-power of investable assets. The tools they use will eventually find their way to the mainstream middle class investor. A few entrepreneurs have spotted this and are executing on that dream, it is too big an opportunity to ignore.


  1. […] This consolidation phase may reverse premium paid for private company, as investors bid up the shares of the undervalued public companies. That is a good thing for healthy markets where retail investors can hunt for bargains and short over-hyped ventures (which you cannot do in private stocks). This may bring back the crushed dream of a democratized stock market. […]

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