According to Securities and Exchange Commission data, trading in odd lots, which consist of less than 100 shares of stock each transaction, is at an all-time high. According to preliminary estimates for October 2019, odd-lot transactions account for approximately half of all deals. This number is projected to climb now that the majority of online brokers have reduced their regular equity fees to zero and allow fractional share trading.
What impact does odd lot trading have on retail traders? Brokers are obligated by a number of rules, the most important of which is Regulation NMS, to execute your transaction at the national best bid or offer (NBBO).When purchasing an exchange-listed goods, the NBBO is the best available (lowest) ask price, and when selling, it is the best available (highest) bid price. What’s the catch? Because odd lot deals are not disclosed on most public data feeds, traders do not have a clear view of current liquidity, and they are not covered by laws that require the trade to be performed at the NBBO—worse, they don’t know whether they are obtaining the best price or not.
Higher Stock Prices Lead to More Odd Lot Trading
The graphic below, created using the SEC’s Data Visualization tool, displays the proportion of odd lot transactions sorted by underlying stock price. The top line, in purple, indicates that odd lot trading reached the 65% range in June 2019, representing the top 10% of equities by price per share. The bottom red line shows the most affordable 10%. The green line represents the 50th percentile or average price of stocks.
Though there was a jump in June 2019 for the less expensive equities, that group has been chugging along around 10-15% of shares traded in odd lots since 2014. Mid-cap stocks have risen from 24% in July 2014 to over 40% in 2019, while high-cap stocks have risen from the mid-30% level in 2015 to 65% in 2019.
Zero Commission Trades Will Boost Odd Lot Trades
With the extension of zero fee trading for retail transactions, we anticipate that these percentages will rise even further in 2020 and beyond. However, the fact that odd lot deals are not obliged to be accessible to market participants is concerning since it adds uncertainty to the data available to those trading. For equities in the top 10% of their price range, this implies that up to two-thirds of the shares being traded are hidden. You’re not sure whether you’re receiving the greatest deal.
The price of the most active equities is an important consideration for retail traders who execute odd-lot orders. Apple (AAPL), which usually consistently appears on the daily “Most Active” listings, has been trading at or around $250 per share since late summer. That implies a single round lot, or order of 100 shares, would cost $20,000-$25,000, a sum that many small retail investors do not have on hand. However, if they acquire a few shares, say 5 or 10, the move does not entirely destabilize their portfolios. If you’re just trading a number of shares at a time, it won’t matter much if you’re not obtaining the highest potential price on this specific transaction, but if you trade odd quantities regularly, the poor fills might mount up over time.
How it Can Add Up
Assume you purchase 2 shares of Amazon or 5 shares of Apple in odd lot orders twice a month. If you obtain a price of $0.02 off the NBBO for a single deal, it doesn’t seem like much. However, you have lost $168 over a ten-year period.
Prior to the 2008 bull market, many publicly listed corporations would split their shares once it hit $100, or even $50. A stock split is a business operation in which a corporation splits its current shares into several shares in order to increase the shares’ liquidity. It does not increase the firm’s total market value, but it lowers the price per share, making it simpler to trade. If a firm in which you hold stock announced a 2 for 1 stock split and you own 100 shares, you would own 200 shares on the effective date of the split. Historically, the price per share increased after a stock split as trading increased.
However, we are increasingly seeing more corporations avoid splits and just allow their share prices to go into previously unknown ranges. Amazon (AMZN) surpassed $2,000 per share during the summer and spent October flirting near $1,800. If you wanted to buy 100 Amazon shares, the transaction would be worth roughly $180,000. Amazon trades 3.1 million shares each day on average, but Advanced Micro Devices (AMD), which has recently traded between $30 and $35, trades roughly 50 million shares per day. Retail investors who wish to include Amazon in their portfolios are virtually compelled to purchase it in odd lots, which may not be the best available pricing.
Furthermore, if you wish to write a covered call, a common options technique for generating money in the form of option premiums, you must have a round lot on hand since each options contract represents 100 shares of the underlying company.
How HFTs use Odd Lots
Professional and high-frequency traders employ odd lots to test market prices, or they cut a big order into smaller amounts to conceal their activity since stock exchanges only need round lots to be disclosed. For example, Interactive Brokers offers its customers to employ multiple trading algorithms that may send a big order out in extremely little slices, concealing the entire amount of the deal and avoiding price movement per share.
In response to a study by Cornell researcher Maureen O’Hara, FINRA’s then-CEO Richard Ketchum commented about odd-lot transactions in 2014, noting that such deals, which had been removed from the consolidated tape due to their size, play a meaningful role in the market. “When odd-lot transactions were a minor part of market activity, their absence from the consolidated tape was insignificant.” However, due to changing market practices, these lost transactions have grown both common and significant,” Ketchum added. These deals were concealed on the consolidated tape, but not to all market participants. Through its Trade Data Dissemination Service, FINRA started distributing odd-lot transactions on the over-the-counter markets.
NASDAQ introduced odd-lot orders to one of its available order types, the Midpoint Extended Life Order (MELO), which was previously only accessible to individuals submitting round-lot orders, in July 2019. This order type adds a 12-second wait to the transaction in an effort to avoid immediate-or-cancel orders, which are often employed by high-frequency traders to test a changing market. MELO orders, which are utilized by traders with longer-term investment goals, may only be fulfilled by a counter-party who is also employing the same order type. The rule-makers at NASDAQ noted that the number of high-priced securities has expanded in recent years, and that there is a noticeably high proportion of odd lot transactions in such equities. The proposal by NASDAQ to enable odd lot-sized MELOs in order to increase trading prospects for the order type, especially in high-priced securities, acknowledges the emergence of these sorts of transactions.
Financial Information Forum-style Reporting Might Help
Brokers that follow the Financial Information Forum (FIF) reports demonstrate that their odd-lot executions are nearly always conducted at the NBBO or better, but just two do. According to Fidelity, odd lot transactions for S&P 500 equities averaged 27 shares per order in the second quarter of 2019, and almost all were handled at the NBBO. Schwab’s numbers are comparable. However, none of the other brokers provide these figures, so the ordinary online brokerage consumer has no way of knowing.
The next step in increasing openness for odd-lot traders is to demand that such orders be published and utilized in computing the NBBO. Retail traders will place more odd-lot orders when stock prices rise. The remedy is for publicly listed corporations to divide their equities in order to pull their prices down from the stratosphere, or for rules to catch up to present practices.
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