(This article first appeared in the Q4 issue of GlobalTrading.)

With Rob Chechilo, Director, Head of Algo Trading – Americas at UBS;
Ryan Gould, Managing Director, Head of Equity Quant Trading – Americas at UBS;
Andy Kolinsky, Managing Director, Head of Retail Market Making – Americas at UBS;
and Peter Sheridan, Managing Director and Head of Electronic Trading – Americas at UBS

For investment managers seeking trade counterparties, the best market ecosystem is a diverse one, with different types of market participants buying and selling different stocks, at different times, and in different ways.

One market constituency that has gained influence this year, catching the eye of the institutional buy side in the process, is the retail investor. With a ‘perfect storm’ that included zero trade commissions, working from home amid the COVID-19 pandemic, and government stimulus checks, retail trading’s share of stock-market activity has doubled to about 20% in 2020, from 10% last year, according to industry data. The number is closer to 25% in volatile markets. 

“Markets are about connecting different players and their liquidity,” said Ryan Gould, Managing Director, Head of Equity Quant Trading – Americas at UBS. “You have institutional clients who historically use algorithms to gain liquidity, and you have retail clients who trade through the more direct platforms. The markets are trying to match that liquidity.” 

TD Ameritrade added 1.27 million new accounts in the second quarter; Fidelity added 1.17 million new accounts in the second quarter, 2.26 million accounts in the first half of 2020. Robinhood, the upstart platform favored by millennials, added 3 million accounts in the first quarter. E*Trade, Charles Schwab and Vanguard have also reported strong 2020 numbers. 

Size Disconnect

A primary disconnect between retail and institutional traders is size, as even a high net worth trader buys or sells only a small fraction of what a large institution moves in one transaction. That gap has widened this year, as average retail order size has compressed for two reasons: one, Schwab cutting commissions for online trades to zero in November 2019, which prompted its competitors to quickly follow suit; and two, swelling, sometimes four-figure valuations of some of the most actively traded stocks, including Amazon, Alphabet and Tesla. 

“About 60% of retail orders coming in to UBS are for 100 or fewer shares, and orders for just 1 share have increased 300% compared with last year,” according to Andy Kolinsky, Managing Director, Head of Retail Market Making – Americas at UBS. That trend was at least somewhat slowed with Apple’s 4-for-1 stock split and Tesla’s 5-for-1 split, but orders are still smaller than they used to be, and the small sizes carry broader market implications. 

“As order sizes have decreased, the ways that firms think about allowing their algos to interact with this liquidity has changed,” said Rob Chechilo, Director, Head of Algo Trading – Americas at UBS. “Clients value natural liquidity which has traditionally been traded through the use of algo strategies. Using large minimum size thresholds on orders helps to reduce interactions with trading firms but also reduces the opportunity to interact with small retail orders. Tailoring interactions on venues, such as UBS PIN, with retail order flow and counterparty segmentation can maximize accessible natural liquidity.”

UBS PIN (“UBS PIN (US)”), is a differentiated segment of liquidity operated within the UBS ATS that facilitates interaction between any combination of UBS Retail Orders, UBS institutional algorithmic order flow, and UBS Principal Orders in the US. 

“The changes we made allow our algorithmic strategies to interact more often in UBS PIN resulting in improved benchmark performance and reduced benchmark tracking error,” said Peter Sheridan, Managing Director and Head of Electronic Trading – Americas at UBS. 

Another way retail and institutional traders aren’t on the same page is when they’re in the market — retail is more likely to buy and sell at the open of the trading day, while institutions get more interested ahead of the close. Retail’s tendency to trade early in the day has been amplified in the 2020 trend away from ETFs and toward single-stock trading, which typically peaks in the first half hour of trading. 

Bridging the Time Gap

UBS estimates 25% of retail volume trades over the first hour of the trading day, whereas approximately 25% to 30% of overall US composite volume trades in the last half hour of the day. “Generally speaking, institutions that trade in a systematic manner tend to avoid the early hours of the trading day in an effort to reduce trading costs associated with higher volatility, wider spreads and less liquidity,” said Sheridan. “There is a time dislocation, a temporal arbitrage, between retail investors and institutional investors that can be bridged.” 

UBS bridges the retail-institutional time gap with its principal liquidity book, effectively acting as the other side of the trade for a very short period. “By us committing capital to one side or the other, but anticipating that it’s likely that we’re going to have the ability to unwind with one of our other natural clients, it allows us to create a unique source of liquidity,” Gould said. “On a public exchange, you don’t have as much control over the source of the liquidity, and therefore the costs that you might ultimately pay on that larger order that you’re trying to get done.”

“In the current market, people are increasingly looking to their brokers for direct liquidity,” Gould said. “In order to provide high-quality, direct liquidity to enhance best execution, you need to have a diversified pool of clients that trade for different reasons, and you need to be able to naturally pair that.”

“Our competitors in the retail space tend to be principal traders, rather than client-focused firms,” Gould added. “We’re unique in that we’re an institutional client-focused firm that can provide diversified liquidity, and also provide unique insights into the retail investor base that has seen significant growth in market share.”