The Problem with Stocks

The Stock Market, Explained

by Cassie Murdoch 7 MINUTES READ

We’re not gonna lie: The stock market is way too complicated to easily understand. And it’s that way for a reason. It helps the companies that profit the most from the market keep profiting. But we promise it’s worth pushing through the jargon to wrap your head around it. Really. The more we all understand, the easier time we’ll have pushing those in power to make it more fair for all investors, not just the chosen few. Read on for everything you need to know about what’s wrong with our stock market.

Let’s start with the fundamentals

The premise behind stocks is simple: People invest money in companies they believe in, and if the companies do well, then they do well. For most of history, however, in order to actually buy stocks you needed a broker to act as the middleman – he took your money and used it to buy you shares in a company. Naturally, the brokers didn’t do this work for free, and this made it almost impossible for most of America to participate in the stock market. Make no mistake, the stock market was an elitist operation from the very first ring of the bell. 

the stock market illustrated

Obviously this set-up led to significant inequality in the market. The Federal Reserve began analyzing stock ownership in 1989 and found the top 10% of households owned 78% of the market. Eventually, with the dawn of the internet, discount e-brokers like E*Trade emerged and tried to democratize the market. Though this did lead to more people entering the market, the inequality in the market went up right along with it. 

But don’t worry, finally Robinhood came along to save the day! You know the one who steals from the rich and gives to the poor? Well, sort of. This Robinhood was less of a folk hero and more of an app that let people trade with no fees or commissions. So now anyone could invest, no middleman or exorbitant fee needed. Hurrah, we can all get equally rich! Equal! Rich! Two words that have always gone together in America!

in 2021, more money entered the stock market than in the previous 20 years combined.

As retail investing became more accessible, low interest rates made it more difficult to grow wealth in a personal savings account, giving people an even bigger incentive to start investing. In fact, in 2021 more money entered the stock market than the previous 20 years combined. You’d THINK this would FINALLY make the stock market more equal but sorry, kid, you’d be wrong. Inequality has continued to rise. GAHHHHHH.

So, in short, those who control the market keep driving more and more people into trading, but they’re still the ones who know how to profit the most. This formula seems…. bad. Are we missing something here? Is there a greedy cabal of old white men doing something dastardly behind the curtain? Would it even be America if there wasn’t?

What is Robinhood wearing under those tights?

Let’s take a closer look at what’s actually happening when you trade on an app like Robinhood. You’d think, given how we’re led to believe the stock market works, that when you hit the “buy” button on an e-brokerage app like Robinhood, your order would go directly to the stock exchange, your money would then be traded for a share of stock, and then you’d be the proud owner of FUK because you know nothing about stocks but that one made you laugh. But, alas, this is where this story turns dark.

What actually happens the majority of the time when you hit “buy” on the app is called “Payment for Order Flow.” That’s when your order and money go to big Wall Street firms called “market makers” — basically middlemen who match buyers to sellers. Citadel and Virtu are two of the biggest market makers.

Payment for order flow, explained in illustrations

 

Is this really any different than an old-fashioned broker? Eh, not completely, except this guy is hiding in the closet and most investors have no idea he’s there or taking money off every trade you make. 

Anyway, these orders rarely go to the stock exchange. Instead, market makers match them with other orders they have also already paid for, or they slip these orders into what are called dark pools. What a completely normal and not at all terrifying thing to call something.

What’s in it for market makers?

Market makers pay Robinhood and other trading platforms a ton of money for the privilege of doing this matchmaking, and would you believe they’re not doing this out of the goodness of their heart? They’ve said it’s because they want to keep the market democratized, but here’s the reality: Payment for Order Flow allows market makers to use the small differences between the price a stock is bought and sold for to make pennies off of every transaction they process. 

This doesn’t sound like a big deal, but when you consider the gazillions of transactions they’re processing, you realize that actually a gazillion pennies is quite a lot of money.

Payment for Order Flow is a scheme so clever that it only could have emerged from one man’s brain. And that man is Bernie Madoff. Yes, we were shocked too. If this set-up sounds as illegal as some of the other things Bernie Madoff did, you’re right. It’s actually already illegal in many other countries, and there’s a push to outlaw it in the U.S., but for the moment, it’s perfectly legal. Now we see why the rich men in charge want a “democratized” market: The more people who are trading, the more money they can make off of them. 

The really scary part of the dark pool/Payment for Order Flow mess is that it’s one of the most transparent parts of the stock market. Doesn’t bode well for our future of not being completely fucked over! There’s an entire other landscape of sketchy transactions out there that are even more sinister and complicated that no one even knows about. 

The market is more fragile than the bones of the average CNBC viewer

This is pretty comparable to the subprime mortgage crisis in that it could easily obliterate things like normal people’s retirement accounts if the house of cards comes crashing down. Boy, that sounds like pretty big news. You’d think the financial media would be all over it, but nah… CNBC and the rest of them haven’t exactly blown the lid off this scam. 

It took a bunch of Redditors on the subreddit r/WallStreetBets to bring it to the world’s attention. (You can read more about that here.) They started digging around to figure out what was going on behind the curtain and ended up pushing the market to the breaking point because all of this complexity has made it so very fragile. 

At this point, the stock market is essentially a casino — except casinos are really well-regulated. If we want to make our market good for actual investors, as opposed to the few elite firms that control it, it’s gonna take a big push for better regulation and transparency.

Want to know the best ways we can do that? Click here.