How Retail Investors Are Changing the Stock Market

If retail investors continue to operate on stock markets, major changes will occur.
Heya Shah, stock market news, retail investors, social media and stock market, GameStop stock price, Black Tuesday 1929, Great Depression, Robinhood Reddit, stock market trading, finance news

© katjen / Shutterstock

August 30, 2021 11:53 EDT

Retail investors are non-professional investors who, instead of keeping their money in the bank or investing it in mutual funds, invest directly in the stock market for higher returns. Often, retail investors don’t have in-depth or professional knowledge of the stock market.

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Historically, professional investors have dominated stock markets. These investors assimilate vast amounts of information and make difficult investment decisions, sometimes on a daily basis. Picking the right stock among the thousands on offer can be daunting, especially for retail investors.

Retail Investing on the Rise

During the COVID-19 pandemic, the number and impact of retail investors have increased dramatically. Retail investors now account for almost as much volume on the US stock market as mutual and hedge funds combined. On the Indian stock market, the percentage of individual investors increased from 33% to 45% over the last five years. In this period, the percentage of institutional trading by both foreign institutional investors and domestic institutional investors declined from 32% to 18%. Retail investors increased their purchases on the London Stock Exchange as well, now holding 15% of the UK stock market. 

The rise in retail investment is the result of many factors. First, a number of people have more free time on their hands and need alternative sources of income. The COVID-19 pandemic spurred a global trend in working from home. Employees were no longer commuting and had more time to explore the stock market. Furthermore, many found themselves in economic distress. As jobs and salaries were slashed when businesses suffered severe setbacks and even went bankrupt, many turned to the stock market in search of alternative sources of income. 

Second, retail investors found a favorable opportunity to invest because of the dramatic crash in stock markets in the early days of the pandemic. The US Dow Jones Industrial Average fell by a whopping 37% from early February to March 2020. Stock markets worldwide saw a similar plunge. This gave many first-time investors an opportunity to invest in stocks at significantly lower prices while the market was bottoming out. In the past, after the 9/11 attacks of 2001 and the market meltdown of 2008, retail investing went up as well. It seems many invest in stock markets at times of crisis in the hope of earning profits when the markets rebound.

Third, retail investors were chasing higher returns at a time when central banks slashed interest rates to extremely low levels. To support businesses and increase consumer spending, central banks adopted extremely loose monetary policies. While liquidity went up, the returns offered by most traditional investment options remained poor, making people turn to the stock market.

Fourth, data reveal that many US citizens used the COVID-19 stimulus checks to invest in the stock market. 

Fifth, online trading platforms made it more accessible to trade on the stock market. Prior to the growth of such platforms, stockbrokers charged high commissions, asked for minimum account sizes, levied fees for inactive accounts and demanded subscription payments. Online platforms like Robinhood in the US, FreeTrade in the UK and Zerodha in India made the online trading process seamless for retail investors and disintermediated traditional stock brokers. Investing in stock markets has become easier and cheaper.

Finally, retail investors now have easy access to information about stock markets through platforms like Reddit. On one subgroup, r/wallstreetbets, retail investors discuss what stocks to purchase and reasons for doing so. This gives them the confidence and the direction to purchase stocks.

Retail Investor Mentality

Retail investors tend to be bullish about the market. They are more optimistic than professional investors and represent a younger demographic with a median age of 35, down from 48 before the pandemic.

These younger investors often navigate by sentiment in contrast to older and professional investors who are more conservative. Many of these investors have yet to experience a bust and pay less attention to company finances. Younger traders tend to jump from one hot trend to the next. In March 2020, they bought shares of airline companies and cruise ship operators on the assumption that the economy would reopen shortly. Apart from trends, younger retail investors tend to buy shares of companies in technology and gaming, their areas of interest.

One such bet has made international headlines earlier this year when GameStop, a struggling video game retailer that operates over 5,000 stores in the US, suddenly saw retail investors buying up its stock in droves in January. Many professional investors were shorting the company’s shares, which involves selling shares with the aim of buying them back later for cheaper prices. Professional investors estimated that GameStop’s business would go down in the pandemic, meaning that its share price was bound to fall. Retail investors took a different view. 

Some retail investors spread the message to buy GameStop shares on r/WallStreetBets, which led to GameStop’s share price rising by nearly 1,900% in less than a month as investors started buying. Those who shorted the GameStop stock, including hedge funds like Melvin Capital Management, lost nearly $6 billion. Most GameStop stock was bought on online trading platforms like Robinhood. 

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The GameStop trading frenzy is one of the clearest examples of a shift in power on the stock market. As of August 27, GameStop’s share price was $204.95, below the $347.51 peak in January, but still much higher than the $17.25 mark at the end of 2020. This shows that retail investors can take on professional investors and win, at least in the short term.

Interestingly, the GameStop saga is not a one-off event. Shares of AMC Entertainment, a movie theater chain, rose by approximately 2,900% in May and June when information circulated on Redditt platforms caused stock purchases. Sophisticated institutional investors were selling the company’s shares because of its financial troubles, while retail investors continued to buy. GameStop and AMC shares fired up by retail investors using Reddit have been labeled as meme stocks.

Retail investors are causing many changes across the markets. The share prices of many companies, especially smaller-cap ones, have become more volatile. Many professional investors believe that this volatility is driven by irrational and unpredictable investing by novices. Speculation and rumor now play a bigger role because information on social media is rarely fact-checked. Besides, social media traps people in echo chambers where they engage with others who hold similar viewpoints and beliefs. This leads to mob investing, exacerbating the already increasing volatility of stock markets.

Here to Stay?

If retail investors continue to operate on stock markets, major changes will occur. They have caught the investment bug and might become seasoned investors with time. The influence of social media on stock markets might increase as well.

Some market veterans take the view that rising retail investing is a passing trend. History suggests that, more often than not, retail investors have lost money on the stock market. Their investments tend to be in companies with unsound fundamentals. They lack the training, experience and judgment to invest wisely. 

History offers a sobering example. October 29, 1929, when markets crashed, leading to the Great Depression, is known as “Black Tuesday.” Billions of dollars were lost and thousands of investors wiped out. This could happen again. Inflation is rising. Interest rates might follow suit. Other investment options might become more attractive, and the stock market might suffer. This could easily lead to retail investors fleeing stock markets much in the same manner as they have flocked to them.

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.


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