The other day I was asked about the stock market and how it works. There is no longer a stock market, there are lots of stock markets, many of them are what are called "dark pools". A dark pool is a stock market that is taking place without the public being able to see what is going on.
For all intent and purposes the stock market really doesn't exist any more. When the pictures of the stock market come on the news, think movie set because that is all it is. The people in the background are office workers being used as set dressing and the paper on the floor is tossed there to look good. If you want to see what the stock market do a quick google search for the trading floor in the eighties and early nineties. Here is the way it worked: the stock broker got an order. He sent the order to Wall Street. The Wall Street rep contacted the right floor trader. The floor trader worked in what was called pits, a booth were the trading took place. The bid, yelled, waved hands, and plowed their way through other traders to get the attention of the pit traders. The pit traders were the ones who took the buy order from trader 1 and the sell order from trader 2 and put them together. To be a floor trader you had to have a seat on the exchange or work for a company with a seat and you had to be hard as nails as the job could get very physical very fast. The trading pit was the place you could see a professional football player get tossed to the side by a much smaller person.
After the exchange, the market did what is called "settling". All settling means is the buyer has to pony up the money to pay the seller. Settlement is very important as it not only gets the seller paid, but also gives the buyer undisputed ownership of the stocks in question.
Fast forward to today and computer trading. What used to be carried out at the pits is now carried out by computers many, many times faster. Ah, but wait, there is more. A lot more. Michael Lewis covered this very well in his fascinating book "Flash Boys". I won't go into the background of how modern computer trading came to be, please read the book for background info on it. The book is easy to read and captivating to boot.
Keep in mind with computer trading came speed. We are not talking minutes or seconds, but nanoseconds. A nanosecond is 1,000,000,000 of a second and banks fight over them.
Okay, lets tackle the dark pools. One day you wake up and decide it is a good time to buy stock in ABC corp. At your computer you place a buy order for a block, 100 shares, with your favorite trading platform and in a few seconds the screen tells you congrats you have the stock. Do you have any idea where the trade took place? Most people think the public stock market, but not so. The trade may have been completed in the dark pools of one of the big banks. The Too Big To Fail banks. How does this mater to you? Well, it really doesn't because buying a block of stock won't attract the attention of anyone but the broker billing for the purchase. But, what if you were a pension fund and your fund purchased lets say 1,000 blocks or a hundred thousand shares. Now the sharks move in.
Remember speed. Once your order is placed, and lets say you told your broker you were willing to buy said stock at 120.00 to 120.05 per share. The order is placed. The first 2K of stock is bought at 120.00/share as you knew it would be because on your trading screen that is what it said. What about the other 98K of stock. That is where the speed comes in. The computers of the big houses are way ahead of your trade. They go out and buy 98K worth of stock at the 120.00 level. Maybe even several houses get in on the feeding frenzy and they each get a part of the trade. The price now goes up to 120.05, your top bid. The trading computers know your top bid because your broker can't afford a computer that trades in nanoseconds. Your order is rerouted to the dark pools, trading platforms inside the banks control, private trading platforms, and the order is filled costing you and extra $1,960.00. Wow, big profit for the bank, right? The banks running the dark pools have no trading fees, it is all profit for them and they can do this kind of trading thousand of times a minute. Yes, massive profits and the person buying the never stood a chance.
What about settling you ask? The stock market as it sits has not been settled, from what I've read, in five years. The trades are happening so fast it never gets settled and the same share of stock may be owned by four, five, maybe six people. Who owns it? Who ever gets to do the settling, my bet is the bank will wind up owning it, unless you have a paper certificate. Paper certificates used to go along with buying the stock, now you have to pay to get them, but it would be the only proof you really own the stock.
Still think the stock market is freely traded?
Till next time.
