According to statistics published by the Securities and Exchange Commission, trading in odd lots, which comprise fewer than 100 shares of stock per transaction, is hitting historic highs. Preliminary statistics for October 2019 show that odd-lot trades, as a percentage of total trades, are nearly half of the market. Now that the majority of online brokers have cut their standard equity commissions to zero, and are enabling trades of fractional shares, this figure is expected to rise.
How does odd lot trading affect retail traders? Brokers are required, under a variety of regulations but most notably Regulation NMS, to execute your order at the national best bid or offer (NBBO). The NBBO is the best available (lowest) ask price when you are buying an exchange-listed product, and best available (highest) bid price when you're selling. The catch? Odd lot trades are not reported on most public data feeds, so traders do not have a complete picture of the current liquidity, and are not covered by regulations that require the trade to be executed at the NBBO--but worse, they don't know if they are getting the best price or not.
Higher Stock Prices Lead to More Odd Lot Trading
The chart below, which can be built using the SEC’s Data Visualization tool, shows the percentage of odd lot trades sorted by the price of the underlying stock. The top line, in purple, shows that odd lot trading hit the 65% range in June 2019, represents the top 10 percent of stocks by price per share. The bottom red line represents the least expensive 10 percent. The green line is the 50th percentile or the average price stocks.
Though there was a spike in June 2019 for the cheaper stocks, that group has been perking along at 10-15% of shares traded in odd lots since 2014. The mid-range stocks have increased from 24% in July 2014 to over 40% in 2019, while the most expensive stocks have jumped from the mid-30% range in 2015 to 65% in 2019.
Zero Commission Trades Will Boost Odd Lot Trades
With the expansion of zero commission trading for retail trades, we expect these percentages to go even higher into 2020 and beyond. But it's troubling that odd lot trades are not required to be visible to market participants because that adds more uncertainty to the data available for those trading. For stocks in the top 10% of the price range, that means that up to 2/3 of the shares being traded are not displayed. You don't know for sure that you're getting the best price.
A key factor for retail traders who execute odd-lot orders is the price of the most active stocks. Apple (AAPL), which almost always appears on the daily “Most Active” lists, is trading for over $200 per share, and closer to $250, since late summer. That means a single round lot, or an order of 100 shares, would cost $20,000-$25,000, a figure many small retail investors don’t have on hand to put into a single position. But if they buy a few shares, say 5 or 10, that trade doesn’t throw their portfolios completely out of balance. If you're trading just a couple of shares at a time, it won't make a huge difference that you're not getting the best possible price on this particular transaction, but if you trade odd lots frequently, over time the bad fills can add up.
How it Can Add Up
Let's say you place odd lot orders twice a month, buying 2 shares of Amazon or 5 shares of Apple at a time. For a single trade, if the price you get is, let's say, $0.02 off the NBBO, that doesn't sound like much. Over a ten-year period, though, you've lost $168.
Prior to the bull market that began in 2008, many publicly traded companies would split their stock when it approached $100, or even $50. A stock split is a corporate action in which a company divides its existing shares into multiple shares to boost the liquidity of the shares. It doesn’t add to the overall market capitalization of the publicly traded firm, but it brings the price per share down, making it easier to trade. If a company in which you own stock announced a 2 for 1 stock split, and you own 100 shares, then on the effective date of the split you would own 200 shares. Historically, following a stock split, the price per share would increase as trading picked up.
But now we are seeing more companies avoid splits and just let their share price move into ranges previously unseen. Amazon (AMZN) topped $2,000 per share over the summer and spent the month of October flirting with the $1,800 mark. If you wanted to own 100 shares of Amazon, you’d be looking at a trade valued at nearly $180,000. Amazon is trading, on average, 3.1 million shares daily while a stock such as Advanced Micro Devices (AMD) trading between $30 and $35 lately, sees nearly 50 million shares change hands daily. Retail investors who want Amazon in their portfolios are essentially forced to buy it in odd lots, and may not be getting the best available price.
In addition, if you want to write a covered call, a popular options strategy used to generate income in the form of options premiums, you must have a round lot on hand as each options contract represents 100 shares of the underlying stock.
How HFTs use Odd Lots
Professional and high-frequency traders use odd lots to test the market price, or they chop a large order into smaller sizes to hide their activity since only round lots are required to be displayed by stock exchanges. Interactive Brokers, for example, allows its clients to use several trading algorithms that can send a large order out in very small slices, thus hiding the total size of the trade in order to avoid moving the price per share.
FINRA’s then-CEO Richard Ketchum spoke about odd-lot trades in 2014, saying that such trades, which had been excluded from the consolidated tape because of their size, play a relevant role in the market, in response to a study by Cornell researcher Maureen O’Hara. “When odd-lot trades represented a trivial fraction of market activity, their omission from the consolidated tape was of little consequence. But new market practices mean that these missing trades had become both numerous and important,” Ketchum said. While these trades were invisible on the consolidated tape, they were not invisible to all market participants. FINRA began disseminating odd-lot transactions on the over-the-counter markets via their Trade Data Dissemination Service.
In July 2019, NASDAQ added odd-lot orders to one of its available order types, the Midpoint Extended Life Order (MELO), which had previously only been accessible by those entering round-lot orders. This order type added a short pause of ½ of a second to the transaction in an attempt to stave off immediate-or-cancel orders, typically used by high-frequency traders to test a moving market. MELO orders can only be completed by a counter-party also using the same order type, and are used by traders with longer-term investing horizons. NASDAQ’s rule-makers recognized that the number of high-priced securities has increased over the last several years and there is a notably large percentage of odd lot trades in those stocks. NASDAQ’s proposal to allow odd lot-sized MELOs in order to provide additional trading opportunities for the order type, particularly in high-priced securities, is an acknowledgment of the rise of these types of trades.
Financial Information Forum-style Reporting Might Help
Brokers who conform to the reports designed by the Financial Information Forum (FIF) show that their odd-lot executions are almost always executed at the NBBO or better, but there are only two who do so. Fidelity reports that in the 2nd quarter of 2019, odd lot transactions averaged 27 shares per order for S&P 500 stocks, and almost all were executed at the NBBO. Schwab's statistics are similar. But none of the other brokers report these statistics, so there is no way to know for the average online brokerage customer.
The next step to provide additional transparency for odd-lot traders is to require those orders to be displayed, and used in calculating the NBBO. As stock prices increase, retail traders will be placing more odd-lot orders. The solution is to either pressure publicly traded companies to split their stocks to bring their prices down out of the stratosphere, or for regulations to catch up to current practices.