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WHEN THE ELEPHANTS DANCE
by Wayne H. Wagner
Plexus Group, Inc.

What happens to retail investors when the institutional investors are active in a stock? Do individuals become the mice trampled by the elephants' dance?

Certainly, institutional trading dominates the markets. The NYSE estimates that 85% of their trading occurs in institutional sized amounts. According to Plexus Group figures on 80 large institutions, the average institutional trade is 19 thousand shares representing 28% of a day's volume in NYSE stocks, and 20 thousand shares representing 40% of a day's volume in NASDAQ stocks.

As large as these numbers are, they still hide the size of institutional trading. What is revealed to the market on any day is controlled by the institutional trader, who is working on an order given to him or her by a portfolio manager. The average portfolio manager order often involves many days' volume, resulting in trading that stretches out over many days. Plexus calculates that the average same-name order to the trade desk is 120,000 shares representing 1.25 days' volume in large cap stocks, and 50,000 shares representing over four days' volume in NASDAQ stocks. Like the Titanic pilot, they see the danger but cannot turn quickly enough to avoid collision.

Even that may understate the institutional effect of institutional trading. Institutions are acutely attentive to company and market information, and thus likely to trade simultaneously as their sharp-eyed analysts spot a change in company prospects. Finally, many institutional portfolio managers are keenly tuned to momentum behavior of a stock, adding to orders when the market behavior confirms the manager's opinion.

Put this together, and institutions will dominate any stock when they are actively trading. Their actions will dominate the volume and determine the price. Like a mouse on the back of an elephant, the individual investor is going to travel in the same direction as the elephant.

This trading is not only different in size, it is qualitatively different as well. The Securities and Exchange Commission believes that market transparency of orders and trades benefits the individual investor. Unfortunately for the institutional trader, transparency is not a friend. The biggest fear for an institutional trader is that early trades will tip off the market that there are more shares to be bought.

There is no more valuable information in the market than knowledge of unfilled trading interest, particularly in the NASDAQ market. Many eyes watch the daily trading to spot trends and hints of concentrated buying and selling interest. Here the mice, in the form of adroit retail day traders, can accumulate significant shares in front of the big trader, with the intent to sell it back to him at a profit. This raises the price of the average share bought by the institution, leaking information and sapping performance. This gives the institutions and the dealers working with them fits.

The best way around this problem for the institution is to try to find institutional sellers of the same size as the buyer and arrange a large trade before either side affects the price. Discrete inquiries can be made through full service dealers or through electronic crossing networks. These trades must still be recorded, and the record of the trades opens a window for retail traders to see what the institutions are doing.

Of course, institutions don't dominate every stock. They are under-represented in the very largest capitalization stocks, as well as the stocks which are too small to take an institutional sized bite.

In the give and take of the market there will be winners and losers. Performance results show that no systematic transfer of wealth from the retail to the institutional investors, despite the research advantage of the institutional investors. No reverse Robin Hood effect of taking from the dumb and giving to the rich. Why not?

Retail investors have some advantages of their own. Often they know companies from personal experience that helps them invest. Because they don't have the burden of billions of assets to move around, they can be more adroit traders. Finally, since they are intimately in touch with their own investment objectives, they often have longer horizons and holding periods.

Enjoy the ride.