How The Little Guy Got A Fairer Chance To Profit In Stocks

Investor's Business Daily

On April 9, 1984, the first day of publication for Investor's Daily, the New York Stock Exchange traded 55.1 million shares. Chrysler was the most active issue, up 1-1/2 points to 24 on 1.27 million shares.

Today the NYSE might trade more than 800 million shares on a given day, with an additional 2 billion on the Nasdaq. Stock prices are quoted in decimals rather than fractions, and Facebook (FB), whose CEO, Mark Zuckerberg, wouldn't be born for another month, averages nearly 62 million shares a day.

To paraphrase a 1980s TV ad, it's not your father's stock market.

The market's changes over the past three decades are profound and mostly good. Competition, technology, regulation, deregulation and innovation have combined to level the playing field for the individual investor, giving him or her tools only professionals in Manhattan skyscrapers once had.

In 1984, if you wanted to check your stocks, you called your broker or waited for the next morning's newspaper. Now you have access to real-time news, quotes and streaming charts on your cellphone, often for free. You can get alerts and make trades while waiting for the bus.

The increase in trading volume alone has made the market more liquid. But other changes, many under the hood, so to speak, have made the stock market a better, fairer place. And the market has played a crucial role in economic growth and the development of technology that enriches our lives.

• The rise of the Nasdaq to challenge the NYSE as the pre-eminent exchange was one key development. The over-the-counter market of 30 years ago was the repository of mostly small, newer companies that couldn't meet the NYSE's listing requirements. It was an electronic platform from the beginning.

"From our first day, every other market in the world was floor-based," said John Jacobs, a 31-year Nasdaq veteran. "Today none of them are. Trading across all markets is electronic.

Jacobs recounts how the Nasdaq rode and helped drive two important themes of the past 3 decades: the rise of the IPO and the technology boom. In 1980, there were 71 IPOs that raised less than a billion dollars. IPOs peaked in 1996, with 676 companies raising $42 billion.

Companies such as Apple (AAPL) and Microsoft (MSFT) went public on the Nasdaq and never saw a reason to move to the Big Board.

• The first ECN, or electronic communication network, was Instinet, founded in 1969 for institutional investors. ECNs match trades electronically off traditional exchanges and collect a small fee for doing so. They were direct low-cost competition to the Nasdaq and the NYSE, forcing them to handle trades more cheaply and efficiently.

Archipelago was one ECN and is now merged with the NYSE.

• In 1984, specialists handled NYSE trades and market maker transactions on the Nasdaq. They exacted what was called the hidden eighth from each share traded. "In the old days, if you wanted to place an order to buy a Nasdaq stock, your order was not displayed. The market maker could and would trade ahead of you all day long," said Frank Hathaway, Nasdaq's chief economist. "That's now changed. There's an open order book and no preferential treatment.

• In 2001, the Securities and Exchange Commission ordered that stocks be priced in decimals rather than fractions, as they had for nearly 200 years. That meant buyers and sellers could find prices between the spread of the bid and asked prices. That brought down trading costs further and forced the exchanges to automate even more.

Hathaway noted that in the 1990s, Waste Management (WM) had a spread of 37.5 cents a share. Today it's a penny. A very active stock might have had a 12-cent spread. Now it's a penny.

• In 1975, the SEC deregulated commissions. A Wall Street firm might have charged you a few hundred dollars to buy 100 General Electric shares. Charles Schwab made trades for $70 and later $12.95. Competition brought commissions below $10.

• In the second half of the 1990s, brokers went online. This meant anybody could be a day trader on a laptop in their bedroom.

There have been other important developments.

• ADRs, or American depositary receipts, go back to 1927, but became big business in the past two decades. They are a way a foreign company can sell shares on a U.S. exchange. U.S. investors can more easily invest in overseas companies, and those firms have access to a vast pool of American capital.

The rapidly modernizing Chinese economy has taken advantage of ADRs. While there have been plenty of accounting scandals, ADRs let U.S. investors take advantage of top growth companies such as Baidu (BIDU) and Sina (SINA).

• In the 1970s, Congress passed laws that paved the way for individual retirement accounts and 401(k)s. That spread stock ownership to more families as mutual fund ownership exploded. In 1984, 4.6 million households, 5.7% of the total, owned a mutual fund. Now it's 57.7 million households representing 47% of the total.

• ETFs, or exchange traded funds, allowed diversification with a mouse click. In the 1990s, State Street Global Investors introduced Spyders that trade like a stock and track the S&P 500. That was followed by Dow Diamonds and the QQQs that track the Dow Jones industrial average and the Nasdaq 100.

In 2008, the SEC allowed the creation of actively managed ETFs.

ETFs and exchange traded notes now number 1,500 compared with a handful two decades ago. Global ETF assets amounted to $1.7 trillion at the end of 2013, an increase of $300 billion the year before. ETF trading amounts to 20% of Nasdaq volume.

• Some regulatory changes, while well-meaning, may have had unintended consequences. Regulation FD, for fair disclosure, was adopted in 2000. It says companies can't whisper to analysts information they don't make public. It's been popular with individual investors, but may cause greater volatility, especially around earnings announcements.

• The new stock market accessibility has led to the growth of active traders, says Kelli Keough, an executive with Charles Schwab. For brokers, their numbers are small, but they drive a significant amount of retail trading.

"They are fully engaged with the market," Keough said. "They've been trading an average of 10 years, but they still want to learn. They have a vast appetite for learning. For them, it's more than a hobby. It's a journey.

This new breed tends to be male and close to retirement and has average assets of $700,000 held by Schwab.

A younger group is taking notice of the market. Over the past few years, the average age of Schwab's active trader has dropped 14 years. And about 30% are women.

Beating The Bogeymen

With each market advance, highly publicized bogeymen have shaken public confidence.

In the 1980s, it was program trading. In '98, Long-Term Capital Management, a hedge fund run by two Nobel Prize-winning economists, made a bad bet on Russia's ruble and nearly brought the banking system down. Hedge funds became a pejorative in many people's minds.

In 2003 the discovery that a few mutual fund managers working for some of the country's most respected fund families were skimming profits that belonged to their shareholders also hurt confidence.

In the dot-com boom of the late '90s, some people thought stock trading from your PC was the road to quick riches. In the dot-com bust, they found out it wasn't.

Now high-frequency traders stand accused of skimming billions by trading ahead of everybody else with superfast computers and preferential access.

Regulators unintentionally created the loopholes that led to flash trading. New rules may close these firms down but spawn fresh unintended consequences.

Sometimes the significance of these scandals has been blown out of proportion by headline-hunting politicians. In every case, the harmful elements went away, often due to regulation and prosecution, but sometimes from competition and the efficiency of the marketplace.

The American stock market has turned out to be a wonderful driver of economic growth and wealth creation that lets the little guy in on the secret.

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