Plato Partnership Releases Independent Research on Retail Trading in European Equity Markets
Plato Partnership, a not-for-profit member organisation bringing creative solutions and efficiencies to today’s equity marketplace, today released independent academic research which examines the rise in retail trading activity in recent years. The research has been conducted by Carole Comerton-Forde, Professor of Finance in the Department of Finance at the University of Melbourne, and Fatemeh Aramian a Postdoctoral Fellow in the Department of Finance at the University of Melbourne.
The research examines retail-specific trading mechanisms available in European equity markets. It documents the features of these trading mechanisms and uses the existing academic literature to gain insights into which mechanisms will likely lead to the best outcomes for retail investors.
The paper discusses the recent growth in retail trading activity fuelled by low or no brokerage commissions, easy access to trading applications and the COVID pandemic. Focussing on the retail-specific trading mechanisms, the paper shows that these mechanisms accounted for 2.2% of euro volume in January 2019, peaking at 4.8% in January 2021 for stocks in the main index in Germany, France, the Netherlands, and the UK.
Commenting on the research, Mike Bellaro, CEO of Plato Partnership, said: “It’s clear that retail trading activity across global capital markets has grown significantly in recent years. As market participants, it is crucial that we understand why this has happened and what steps we must take to adjust to the trend. This research is invaluable in helping us to understand how retail-specific mechanisms work and the factors that lead to the best outcomes for retail traders.”
The paper draws on the findings of a large body of academic research to understand the likely impact of the features of the retail-specific mechanisms. The key features and the evidence from the literature include:
Single versus competing market makers: Research shows that price competition between market makers enhances liquidity through lower spreads and higher depth. Therefore, mechanisms with competing market makers will likely have better outcomes.
Single versus multiple markets for reference prices: Competition between venues is also an essential factor affecting traders’ execution prices. Therefore, mechanisms that reference multiple venues will likely deliver better prices.
Explicit costs: Retail brokers usually charge retail traders zero or a flat commission while being responsible for covering all explicit costs. As a result, retail-specific mechanisms offering lower explicit costs are attractive to retail brokers even if they do not always offer the best outcome for the customer.
Segmenting order flow: Empirical evidence shows that segmenting retail flow increases the probability of trading with informed traders in all-to-all mechanisms, potentially widening bid ask spreads. Mechanisms that allow retail flow to interact with all trader types may lead to better outcomes.
Payment For Order Flow (PFOF): Empirical evidence suggests that this practice can create conflicts of interest for brokers and may lead to worse execution quality for retail traders.
The paper also makes recommendations for improving our understanding of the retail trading landscape in Europe and ways to improve execution quality. These include increasing transparency through public disclosures and creating a consolidated tape. The authors also highlight the need for empirical research to evaluate the execution outcomes on the different retail-specific trading mechanisms in Europe.
The full research can be read HERE.