Apple 2.0

Covering the business that Steve Jobs built

The invisible hand that pushed Apple up and down for six years

December 16, 2013: 1:29 PM ET

Until last week, 45% of trades were visible to high-frequency traders but not to the public.

nanex

Source: Nanex. Click to enlarge.

FORTUNE -- What if you could see the prices of the stocks you're following only once a day, but other investors following the same stocks could see the prices as they changed?

That, in broad strokes, was the situation from 2007 (when the Securities Exchange Commission created a national market system) until last Monday, Dec. 9, when NASDAQ and the NYSE began reporting small trades of less than 100 shares to the "consolidated tape" -- the stream of prices visible to the public.

That might seem like a minor change, and for most stocks it probably is. Although trade in so-called "odd lots" has increased five fold in the past 20 years, according to Reuters, it still only accounts for 5% of total U.S. equity volume.

But for a high-priced stock like Apple (AAPL), which was selling in lots of 100 for more than $56,000 Monday, odd lots are a very big deal. Most investors can't afford to drop $56,000 in a single trade. According Nanex CEO Eric Hunsader, 45% of all trades in Apple are in lots of less than 100 shares, and therefore invisible to the public under the old regime.

Why does this matter? For one thing it means that for years, trading volume in Apple was being misreported -- a situation that can lead to a stock being mis-priced. The system also advantaged one kind of trader over another.

A 2011 study out of Cornell University found that computer algorithms were using odd lot trades for what the researchers called "price discovery" -- pinging the market with thousands of tiny orders designed to both disguise their intentions and to smoke out the big institutional orders than can push a stock up or down. For the past six years, high-frequency trading computers -- wired directly to the stock exchanges -- could see this information. The public -- until last week -- could not.

Some Apple investors believe this might explain a lot of the strange behavior they've observed in Apple since 2007 -- when the launch of the iPhone coincided with the promulgation of the SEC's Regulation NMS, which created the national electronic market system that high-frequency traders exploit. Apple's share price has moved both ways -- to extraordinary highs and confidence-shattering lows -- at volumes much lower than theory would predict. Invisible odd lot trades could explain the discrepancy.

How will the new reporting regime affect the average Apple investor?

"Several things will happen," says Nanex's Hunsader, a critic of high-frequency trading. "First, games that used to rely on that asymmetric information will no longer work. That in itself is good, with no effort on the part of the investor. Second, it will allow retail applications to better detect the supply/demand picture, etc. By knowing where these odd-lot trades are executing for example."

"Asymmetric information is always bad for the market," Hunsader concludes, "because it drives away some participants from the market. The most resilient market is one with the widest diversity of participants."
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About This Author
Philip Elmer-Dewitt
Philip Elmer-DeWitt
Editor, Apple 2.0, Fortune

Philip Elmer-DeWitt has been following Apple since 1982, first for Time Magazine, and now on the Web for Fortune.com.

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