This article is part of the FT’s Runaway Markets series
The era of commission-free trading has driven a relentless race among US brokers to defend their market share, fuelling a trading frenzy that has set off alarm bells among veteran investors and analysts.
The sector has transformed more rapidly over the past 18 months than at any point since the dotcom boom two decades ago, analysts say. That has empowered day traders but could also be “distorting” their sense of risk, they argue.
US retail investors have piled into equities, with rolling net inflows over the past 22 days reaching $32bn this week from less than $3bn two years ago, VandaTrack data show.
Covid-19 lockdowns and government policy also encouraged the rush. “Low commission rates, enormous liquidity provided by the Federal Reserve, an army of quarantined people sitting at home, many on a pile of savings augmented by fiscal-stimulus checks — it all adds up to an extraordinary situation,” said Joseph Amato, chief investment officer of equities at Neuberger Berman.
Trading in derivatives like options, which tends to be riskier than buying equities outright with cash, has also jumped in the past 12 months as it became easier for retail traders to participate.
“These platforms now give retail investors the possibility to do leveraged trades, and access to options markets which before were limited to funds or institutional investors,” said Patrick Krizan, senior economist at Allianz.
“When you perceive that everyone is doing it, there is a fear of missing out, but also a distorted sense of the risks involved,” he added.
The already hyper-competitive brokerage industry was shaken up by the arrival of Robinhood, co-founded by Vlad Tenev in 2013. The start-up boasted free trading and a slick user experience, and while a sprint to the bottom on fees was already under way, platforms rushed to slash rates to zero.
“Robinhood was a catalyst for a lot of the competitive pressure that the industry saw to make their offerings more user friendly and less expensive,” said Steve Sosnick, chief strategist at Interactive Brokers. “They set out to be a disrupter and they succeeded.”
Major retail brokerages such as Charles Schwab, TD Ameritrade, ETrade and Interactive Brokers in the US moved to free trading from October 2019, spurring a dramatic rise in activity among investors. “If you want people to do more of something, make it free. And the industry made trading free — at least for the end customer,” said Sosnick.
Losing commissions forced brokers to make up the difference on revenue streams such as earning fees from Wall Street firms in return for sending trades to them. This incentivises platforms to encourage more trading activity, market participants say.
Commission-free trading was “propulsive jet fuel” for investors joining the market, said Dennis Kelleher, chief executive of advocacy group Better Markets. “We’ve seen a radical increase in retail trading in the past 12 months as a result,” he said.
That has come at a cost, Kelleher added. “Some of these apps make it so easy and completely disarming as to the risks and consequences of investing money, it’s as if we’ve eliminated license requirements for people to drive cars.”
Brokers such as Charles Schwab and Robinhood also began offering fractional share trading in late 2019, allowing investors to buy parts of shares, lowering the barrier to entry in a market where single shares in popular companies like Tesla and Alphabet can cost hundreds or thousands of dollars.
The development of ever-slicker trading apps, which allow users to rapidly buy and sell stocks and options with just a tap, have made it easier than ever to invest, further removing friction in stock trading.
“The ease of opening an account with digital-only online brokers on your phone means you can count it in button hits,” said Robert Smith, head of behavioural finance at Barclays Wealth and Investments. “Ten years ago you still had to fill in a form to open an account, the platforms were quite arcane in their trading infrastructure.”
As the brokerage industry evolved, the Fed encouraged retail trading by slashing interest rates and announcing an unlimited asset-purchase programme last year, said Eric Stein, chief investment officer of fixed income at Eaton Vance.
“Having zero rates [and] quantitative easing pushes people to do things with money that they wouldn’t ordinarily do,” he said. “The traditional response would be the Fed tightening policy to stop frothiness in asset markets and people doing crazy things with their money . . . [but] the probability of that happening right now is zero.”
Direct aid from Congress since the onset of the pandemic added accelerant. Eligible individuals received $1,200 in the spring, and another $600 payment in December — a portion of which many industry analysts speculate has made its way into stocks.
“Investors have more time, and increased disposable income, which creates the “free money” effect,” said Smith. “People think, what have I got to lose? It’s very easy now to invest your money — but it’s also very easy to lose it.”