By Kirsten Wegner, Modern Markets Initiative
A day after Facebook reported earlier this month that its streak of user growth had come to an end, its parent company’s stock plunged over 26% in its biggest one-day drop ever, losing more than $230 billion in market value and triggering Wall Street’s worst drop in close to a year. That followed a January where Wall Street’s fear gauge, the Cboe Volatility Index, was up 75 percent for the month.
It has thus far been a difficult year for stock market performance and wild volatility. But, investors, especially the new generation of retail investors, can take heart that liquidity in the stock market – the ability to buy and sell stocks – has performed most admirably in 2022 against a backdrop of a chaotic world that included a Covid-19 Omicron surge, rising inflation fears, and the Russian military buildup at Ukraine’s border (to name but a few).
Stock prices will rise and fall – but the markets operated as intended. No flash crashes, no exchange outages – nothing to compare to the old days, as in the 1987 crash, when stockbrokers just wouldn’t answer their phones in a falling market. The Wall Street technology machine that now supports the markets operated without a hitch, ensuring that orders can be entered electronically, and that institutional and retail investors can’t be “ghosted” by some antiquated, phone-based market making model.
Market volatility is nothing new; and exchanges have always appointed intermediaries to manage the market through periods of volatility. Formerly these were floor-based specialists; but now electronic market makers combine human judgment with the efficiency of automation to provide investors liquidity for stock transactions. These intermediaries have special duties and obligations to serve as a counterparty on a trade to buy when no one else wants to buy or sell when no one else wants to sell.
Even with the recent dramatic price swings in the $51 trillion U.S. equities market and the extreme volatility, it has been demonstrated that the markets are working better than ever. In situations of extreme volatility, there has historically been a widening of bid-ask spreads, and drying up of liquidity. However, in today’s modern markets, electronic market makers provide continuous liquidity and catch the so-called “falling knife” and buy when no one else wants to buy.
There are a variety of trading algorithms today – and it is true that some algorithms might become very conservative or pull back from investment in times of extreme volatility. However, other algorithms seek volatility and trade even more often. All the while, the electronic specialists and electronic market makers on the nation’s exchanges are obligated to trade and maintain a continuous and orderly “book.” Despite the high volatility of 2022, the capital markets were able to withstand the storm in large part thanks to automated traders, who pump dependable liquidity into the markets, even when others are afraid to trade during a sell-off.
Despite the relatively minor differences that are enshrined in our myriad policy debates on market structure, it is important to observe that the markets are working well. Over half of American households are invested in the stock market, either directly or indirectly through contributing to mutual funds, 529 College Savings plans, pension plans, 401(k)s or IRAs; and they have the best access and most efficient marketplace in history. With the efficiency of today’s modern markets, the cost of trading has come down from $6 in fees to trade $100 in the 1980s, the equivalent of 600 basis points, to what is now a 1/2 to 1 basis point on average, or roughly a penny to trade $100 of stock, and many retail brokerages now charge zero commission for making trades.
The markets have continued to operate efficiently, and investors were able to easily buy and sell securities, with bid-ask spreads narrower than they were during the Great Financial Crisis. For Main Street investors, narrow bid-ask spreads and dependable liquidity from automated traders are essential, as these fundamentals work to stabilize the market during times of turbulence.
The bottom line is that retail investors should keep their eye on the prize of long-term investing, and that electronic intermediaries are present as electronic market makers on the exchanges allow them to get in or out of a position, and not be locked out of the markets. For those invested in pooled assets such as ETFs, index funds, mutual funds or otherwise, this is especially important as investors may not realize their accounts are being continuously rebalanced, with asset managers needing to get in and out of position to maximize savings for investors.
Kirsten Wegner is the CEO of Modern Markets Initiative, and education and advocacy group for innovation in the financial markets. She is based in Washington, D.C.
