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Who really controls the stock market?

Who really controls the stock market? This is a popular question and one that has inspired many conspiracy theories. There are variations on the obvious answer to this, each with some grain of something.

But first, let’s just answer the question…

Stock prices

The big money guys really control the stock market! 

This is really an easy and obvious answer that can conjure up all manner of images. Portly, well-to-do gentlemen, advanced in years sitting in plush leather furniture in oak-paneled, smoke-filled back rooms of a private club, deciding which company’s stock will rise and which will fall

Here, they’ve all come out into the sunshine for a photo op.

Financers

Of course, you can vary the scene, substitute the portly gentlemen for brasher, flashier Wall Street types, whatever that means but it comes down to the same thing. And it isn’t really what is going on.

I’m not saying that there isn’t collusion and shenanigans in the markets, but really this classic conspiracy theory isn’t necessary and misses an essential point about how markets function. More to the point, if you allow yourself to get drawn into this avenue of thinking you are likely to resign yourself to mediocre results and miss opportunities.

The simple fact is that share prices are set by the tug of war between buyers and sellers.

So how does that work?

The buyers vs the sellers

Buyers and sellersFor each asset being sold in the market, and to keep things simple let’s just think in terms of shares in XYZ company, there is a group of buyers and a group of sellers.

All the buyers want to buy at the lowest price and all the sellers want to sell at the highest price. But some of the buyers may be willing to compromise more than others and some of the sellers may also be more willing to compromise.

Let’s imagine that shares in XYZ were last traded at $100.

Over on one side of our imaginary trading space, there are a group of buyers who might be interested to buy if the price came down to $90. On the other side, there is a group of sellers who might be interested in selling for $110.

Let’s imagine a simple case of one buyer who looks at his watch, or checks the time on his smartphone, sees it’s nearly lunchtime and decides he had enough, and says – OK, I’ll bid $100 for one share.

On the other side there is one seller who is also getting a bit hungry and fed up and before anyone else can react, says – I’ll take your bid. Sold. They swap the share and the $100 and go off to have lunch.

Transaction

A stupid example I know but the point is that a trade happened because at least one buyer and at least one seller decided to compromise. Btw, in the above example, I’m sure they both went Dutch.Going Dutch

All the buyers and sellers in the market know the last prices and the number of shares traded. In other words, they know the recent price and volume history.

We can see that if we change the number of buyers or the number of sellers, or the emotional state of one group vis a vis the other, we can add multiple layers of complexity to this situation. There will likely be many more buyers interested to buy at a much lower price and more sellers willing to sell at a much higher price.

Also, buyers may become sellers if the price is traded into a different range either to take profit or to limited losses and vice versa sellers can become buyers for all kinds of reasons.

The point is, we don’t need the dark rooms and conspiratorial shenanigans to create an effect where prices can seem to move in deep and mysterious ways. There are plenty of real-life reasons for regular buyers and sellers to do that themselves.

So what about the size of orders?

stock shelves

In our simple example if each person were in the market to buy or sell a handful of shares then the playing field would be more or less even. Trades would happen when buyers and sellers agree to meet each other somewhere in the middle of the pitch.

But what if most of the crowd are indeed there trying to buy or sell a few hundred dollars worth or a few thousand dollars worth of shares, but there is a small handful of traders who are buying and selling in the millions or in the tens of millions?

The answer is pretty obvious. If any buyer or seller enters the market trying to buy or sell millions when others are trading a few hundred, then the little traders will be just swept aside.

Wasn’t big money always in control?

You can argue answers to that question in different ways. But it is very illuminating to note that during the booming 1920s, through the stock market crash of 1929, the depression years of the 1930s, into the war years of 1940s to the mid-1950s, institutional ownership in the stock market was less than 10%. So private households held 90% or more of the stocks listed on the exchanges. 1)Source Trends in Institutional Stock Ownership and Some Implications, https://www.q-group.org/wp-content/uploads/2014/01/Keim-InstitutionalOwnership2.pdf

In the mid-1970s institutional holdings of stocks surpassed the 20% mark. By the 1990s it was around 50/50 between institutions and private investors. Today that figure is around 70% institutions vs 30% private investors.

But in terms of trading volume, retail investors account for even less. Exact data may not be available but most experts say that institutions account for around 90% of the trading volume. The flip side is that all the millions of retail investors account for just 10% of the trading volume.

What does that mean for the retail investor?

For the retail investor, this means you can take two kinds of approach. OK at least two kinds, but let’s keep it simple.

Plan A vs Plan B

Plan A

You could do all your research like the big boys and girls, find undervalued companies, buy in, and hope that everyone else will eventually catch up with where you are, drive the prices of your stocks up and you can sell at a profit.

Plan B

Or you can study the markets and try to discern where the institutions are accumulating i.e. buying in positions and where they are distributing i.e. selling out of positions, and try to take a ride on their coattails.

There are going to be variations on plan A and plan B and you could even try a bit of both. After all, institutions are run by human beings who are also susceptible to fun and inspiring stories about a new company or industry that will revolutionize how we live, etc.

But I guess the point is, if you invest in companies because of whatever story about their future you have bought into, i.e. you follow plan A, but institutions take a different view and are running for the exit, you will likely get wiped out.

Plan B is really letting the big institutions do the work for you. It stands to reason that these guys have the best information available to them. They are able to hire the best minds and pay for the best services.

So following more plan B, our task is to work out how to spot what the big players are doing and try to tag along for the ride.

Big institutions

What do we mean by the big institutions, here is a non-definitive list.

  • Banks
  • Savings and loans companies
  • Credit unions
  • Insurance companies
  • Mutual funds
  • Fund managers
  • Hedge funds
  • Pension funds
  • Venture capital funds
  • Large individual investors

Of course, each of these groups is quite different. Banks, savings and loans, credit unions, and insurance companies are all highly regulated. In order to be allowed to operate and provide the financial services they do, there are many rules they have to obey. In return when you deposit your money into a bank, for example, your money is protected by Federal Deposit Insurance Coverage or FDIC. Similar protections are in place for credit unions and others for insurance companies and yet others for savings and loan institutions.

Mutual funds also have to adhere to certain rules to be allowed to offer their funds to the public. Hedge funds are going to have more freedom though there are rules they have to follow. Pension funds also often have target asset allocations they have to adhere to.

How many are there?

“Lots” is the simple answer. In the US there are:

  • around 5,000 to 6,000 banks.
  • around 8,000 mutual funds
  • around 6,000 insurance companies

It gets more complicated when we look at pension funds. There may be around 5,000 pension funds administering defined benefits but less than 100 of these account for more than 80% of the assets under management. There are also around 4,000 hedge funds and around 1,000 venture capital funds.

But we find the same phenomenon in each area. The top 20% or less account for 80% or more of the value.

What keeps them in check

There are a few important points to take on board that govern how these players operate.

  • Many large institutions are bound by their own rules, the rules differ depending on who they are
  • Many large institutions can’t buy penny stocks or Over-the-Counter, OTC stocks. This accounts for the $5 stock rule.
  • Many institutions have so much money to place, they are obliged to buy whole sectors and industries
  • Institutions often have to spread their accumulation or distribution of stock over time to avoid driving the price too far too quickly
  • Some institutions are obliged to stay in the market, so they can’t flee into cash, then they will move into defensive sectors
  • Some institutions trade and invest in seasonal patterns.
  • Institutions often move into small-cap stocks early in the year to grab higher gains, then move back into the safer larger cap in the last quarter to defend the annual and quarterly results
  • Large institutions move through the markets like large ships, they cannot avoid making big waves
  • As a small investor, you can choose to either drown in the wake of the large institutions or ride the waves to profitability.

Maybe a bit too poetic, but the basic point is there.

Ships wake

The institutional signs

There are some obvious ways to see institutional ownership. Most brokerage platforms and some free sources of online information will list such details as the total number of institutions holding shares and the total shares held by institutions.

This is where you can see for example that just under 5,000 institutions hold about 60% of the shares in Apple, Inc, and nearly 2,300 institutions hold just under 64% of the shares in the General Electric Company.

Another interesting metric, though not the same, is what is often called inside ownership. This is the percentage of shares held by directors of the company.

It is possible to read too much into changes in insider holdings though, as they will often make big changes related to their own personal circumstances rather than because of a change of sentiment regarding the prospects for the company.

Many institutions also have to declare their holdings on a quarterly basis. However, there’s the rub. to quote Hamlet. This means that the published data on institutional holdings can be out-of-date.

What you will see over time and where this is published is trends in recent years in institutional ownership. If you are looking to get in on the early stages of a new and promising company whose shares are being accumulated, a steady increase over recent quarters in institutional ownership is a very positive sign.

The $5 rule

Stock heading above 5 dollars

As we noted many big institutions are not allowed by their own rules to invest in stocks whose share prices are lower than $5. This can mean if you are able to spot a company whose share price is set to break through the $5 barrier, it can be a good idea to load up. There is a good chance that institutions are lining up to accumulate as soon as it does get about the $5 mark.

The reverse is also true. If a stock price is set to drop below the $5 mark, many institutions holding shares in that company can be obliged to sell. This is likely to send the price even lower.

Stock heading below 5 dollars

Sector rotation

However, the major shifts in institutional investing tend to show up in whole industry sectors.

Here is an article that explains how to find and invest in the best performing sectors.

The best way to see what institutions are doing is to follow the relative performance of industry sectors. And let’s remember because roughly 90% of trading volume on the markets is due to institutions when sectors are out-performing other sectors, that is likely to be because they are favored by institutions.

Which sectors are favored by institutions also tells us a lot about their general view of the market and economic conditions.

If the technology sector is outperforming, then the institutions are favoring aggressive growth. If consumer discretionary is doing well then institutions anticipate a consumer boom. If utilities, savings, and loans or healthcare are out-performing then the institutions are taking defensive positions, and maybe they are getting ready for a market correction.

Just recently what we have seen is a move out of technology and into energy, commodities, and lastly consumer discretionary probably in anticipation of the economy opening up as the pandemic is better controlled.

Algorithmic trading

You’ll have heard this too. That most trading is executed by computers running algorithms. This will mean they are programmed to buy and sell at specific price points. The price points themselves are either input directly by humans or established by algorithms. But at some point in the chain, a human sets up the algorithm.

So if we know how the algorithms are set up and the systems used, can we use this information to our advantage?

Maybe, but unless you really do have an inside track you may not get very far. There are layers of potential complexity here but it is still mostly a domain for big funds and big money. There is much more that could be said here, but let’s leave that for another time.

Are they really trying to crush the little guy?

I am reminded of that saying – It’s not that I’m paranoid but that doesn’t stop everyone from being out to get me.

Do institutional fund managers go to bed at night dreaming up ways to crush the small investor? probably not. They are far more preoccupied trying to outperform their competitors. But, it is easy for small investors to get trampled and become collateral damage in the market movements and turmoil that can result from institutions competing.

So in conclusion, don’t bother with conspiracy theories saying the stock market is rigged.

Just seek to understand what drives prices and learn how to profit from it.


Questions and answers


Q. Who runs the stock market?

A. The New York Stock Exchange is the name of the organization that runs the stock market in New York.

This article explains the history of the New York Stock Exchange.


Q. Who has authority to regulate stocks?

A. Each stock exchange has the authority to decide which stocks are listed on its exchange. For example, the NYSE has fairly stringent requirements so only financially sound and consistently profitable companies can achieve an initial listing. Another example is the NASDAQ which has less stringent requirements and therefore has many smaller companies that are often at a development stage and may not yet have reached stable profitability. For example, the NASDAQ has many technology and biotech companies.


Q. Is the stock market really rigged?

A. Stock prices are determined by buyers and sellers finding prices where they are mutually willing to make trades.


Single-page summary

Here is a single-page PDF summary of who controls the stock market.

Who really controls the stock market summary


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Disclaimer: I am not a financial professional. All the information on this website and in this article is for information purposes only and should not be taken as personalized investment advice, good or bad. You should check with your financial advisor before making any investment decisions to ensure they are suitable for you.


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References

References
1 Source Trends in Institutional Stock Ownership and Some Implications, https://www.q-group.org/wp-content/uploads/2014/01/Keim-InstitutionalOwnership2.pdf

Andy

12 Comments

  1. Good insights, although it did confuse me a bit. Don’t worry it’s not the article it’s me. A bit too much to take In, but it is important to know about it.

    I was actually thinking of investing a few months back. I even got messages from people telling me to invest in Bitcoin. I don’t know anything about that.

    Information is always useful. In your experience how well has it gone for you?

    • Hi. I am sorry that you were confused. Please don’t hesitate to point out what it was that you found confusing. I think it is quite likely that Bitcoin is going to be even more volatile than it already is. We are likely to see higher highs and lower lows and I wouldn’t be surprised if many people are shaken out by the lows. My experience, is that I have had periods of successful investing and periods of less successful investing. Looking back I would say that the periods when I had a solid system and stuck with it were the more successful. And periods, when I was trying all manner of approaches, were the least successful. Best regards, Andy

  2. I’m going to have to save this so I can reference it later, there’s a lot of information in here, things I’m going to want to get back to so I can apply it to my own investments. I’m still a little new to this and want to have a better understanding. This is a good article, that was understandable and made me rethink some of the trades I was considering.

    • Hi and thanks for the comment. It is an area where there are some common misunderstandings and as we all know some rampant conspiracy theories. But as you say, some of these very important considerations should be taken into account in our own investing. Wishing you all the best of luck. Kind regards, Andy

  3. I have some sort of knowledge when it comes to trading and I would say that this topic is kind of hard to understand but better to understand while in the process of trading. 

    I really liked that at the end of the article you listed questions and answered them, I’m assuming in place of a summary section which is where I got a better understanding since I didn’t have to read too many paragraphs of things I don’t understand.

    Thank you for sharing this information, it helped a lot! Hopefully, I remember this when trading or investing in the future.

    • Thanks for your comment. I am glad that you found the article interesting. Best regards, Andy

  4. Thanks for the informative post on investing! I’ve actually loved to be an investor but found investing to be a bit risky based on personal and other people’s experiences. For example, I experienced some failure exactly when I tried out Bitcoin for the first time, and I was shaken from the trade. Aside from that, I’ve seen occasions of Bitcoin rising and falling over the past years, and there have been times when the Bitcoin market kept falling at a consistent pace.

      But I appreciate the sea of information that you put together in this post. I’ve bookmarked your site and will keep coming back to learn more about investing. Thanks,

    Joyce

    • Hi Joyce and thanks for the comment. Investing in or trading Bitcoin or other cryptocurrencies is indeed highly risky and it would be very easy to be shaken out if this was your first foray into investing. It would have been much better to start with something more stable and more likely to exhibit a slower steadier trend. I am not saying that it isn’t possible to make profitable investments or trades with cryptocurrencies, since many people are, but they are highly volatile and haven’t been around long enough to establish a long track record of performance. Then there is also the inherent risk that any one of them could be worthless overnight if the market decides so. I hope that your next attempts will be more profitable. Best regards, Andy

  5. This was very interesting to read, the case of XYZ company was great because it showed us in a very simple and understandable way how trends work in the stock market.
    The explanation of The $ 5 rule was also interesting. Given that I don’t know much about investing, any such information is always welcome, and your article really offers a lot. I think I will have to read it again because it is really so extensive and detailed.
    Thanks!
    I wish you all the best
    Nina

    • Hi Nina

      Thanks for the positive comment. I am glad that you found the article interesting and I hope useful. Best regards, Andy

  6. Oof – this is a big topic to take on and it seems like a loaded question that could have multi-faceted answers. Clear as mud! While big money definitely moves the market, the little guy watching the “stocks” can occasionally band together in a big enough way to make significant swings possible. The Game Stop scenario that recently made a lot of small-timers rich (and a lot of big guys broke) was a fascinating real-life market study!

    • Hi and thanks for the comment. I think the interesting thing to note with the Gamestop story is that it did result in wiping one particular hedge fund off the map. However, I would not assume that there weren’t other institutional investors that didn’t pile in alongside the small crowd to create the big waves. So while the popular story may well be that a crowd of small investors were able to band together to bring down one of the big boys and cause some serious damage to a few others, I would not discount the likelihood that there weren’t an even larger number of institutions who didn’t profit from the moves as well. These kinds of events always happen when market frenzy sentiments build. Best regards, Andy

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