Is the Stock Market Rigged Against Retail Investors?

If you're a relatively new investor in the stock market-perhaps you jumped in during the GameStop craziness or just finally have been inspired by all those tales of somebody getting rich through trading-you might be asking yourself: Is the stock market rigged against retail investors?

Not an easy question to answer. It should be this big open space where everybody is allowed to buy and sell their shares in firms, hoping to make some kind of profit. If you dig deeper, though, things are not quite that simple. One can have ample grounds to feel that the game is all rigged against them and in favor of the institutional investors-the large Wall Street firms with billion-dollar management-outs, while putting the retail investor at a disadvantage.

So, let's get down to brass tacks.

The Problem with High-Frequency Trading

One of the biggest problems retail investors have to deal with today is high-frequency trading. High-frequency trading involves large financial institutions buying and selling stocks in milliseconds, thus taking advantage of minute changes in the price that occur within just fractions of a second. These firms utilize powerful algorithms and technology that regular investors simply do not have access to.

What does this mean for the average Joe? In a nutshell, it means the price you see if you want to buy or sell a stock may not be the best price that you could get. By the time your trade goes through, these algorithms have already swooped in, grabbed shares at a better price, and flipped them for a tiny profit. Times that by the thousands each day, and these firms are raking it in hand over fist. Meanwhile, your trades are a little slower and often more expensive.

The feeling for many is that this is an unfair playing field, where those that can invest in top-tier technology, along with having access to top-tier data, will always stay on top. It's hard to say the little guy isn't left in the dust here.

The Influence of Institutional Investors

It is not just high-frequency trading that puts the edge in favor of the institutions. The institutional investor, in the form of hedge funds, mutual funds, and pension funds, controls enormous sums of money that can move markets in ways individual investors cannot.

For example, anytime a big institution buys or sells a stock, it does so in such large volumes that the price of that stock can be moved. If a hedge fund buys up millions of shares in a company, then that raises the price. And if they sell, then it drops. That's something retail investors just don't have the power to do, because they are making much smaller trades.

In fact, if you are a retail investor trying to buy shares just before a big institution decides to sell off their position, you may lose money as the price falls. And unless you have inside information-which is illegal, incidentally-you'll never know when those big moves are coming. Institutions do not have to disclose their trades until after they have been executed, leaving the retail investor to react instead of act.

Dark Pools and Hidden Markets

Then there is the dark pool-the private exchanges on which institutional investors can anonymously sell their stocks without the meddling gaze of the public market. These hidden markets make for a very big chunk in all stock trades, allowing major investors to buy and sell big blocks of shares without causing great fluctuations in the market.

This brings up a couple of problems for the retail investor. First, that means you do not get to see all the trades occurring in real time, and that puts you at a disadvantage in trying to make informed decisions. Secondly, it simply furthers the idea that there are two markets: one for the wealthy and powerful, and one for everyone else.

So, Is the Market Rigged?

With high-frequency trading, the huge influence of institutional investors, and the existence of dark markets, such as dark pools, one can't really argue that retail investors don't face a bigger challenge. To say the least, the deck is certainly stacked against the retail investor.

That said, retail investors do not have it impossible to succeed. Many have been able to make smart investments by paying attention to the long term and studying-not jumping into every trend that is out. But you have to take it for what it is: the stock market is just not a level playing field as it is so often made out to be. In fact, the more one can learn about the system at work, the more prepared one is in using it.

What Can Be Done?

There are also growing demands for more regulation in high-frequency trading and greater transparency into dark pools. To some financial experts, these would result in a fairer market. For example, slapping a transaction tax on high-frequency trades could slow the rapid-fire trading that gives big firms such an enormous edge. Making the trades that occur in dark pools more transparent could level the information playing field for all.

But until those changes are made, retail investors need to be aware of the forces at play and adjust their strategies accordingly. The market might not be fully rigged, but it's certainly not set up to make it easy for the average investor to win.