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July 01, 2021 | GSAM Connect

Quantinomics: Rise of Retail Investors and What it Means for Active Management

The level of retail trading activity has doubled since 2016, now accounting for about 20% of average daily traded equity volume within the US. New entrants to the landscape have helped increase the public’s access to the stock market by offering commission-free trading, and in turn, introduced millions of new market participants.1

How might the rise in retail trading and the impact it can have on stock valuations affect active managers and their ability to generate alpha and manage risk? In our view, answering that question requires taking a closer look at the market dynamics associated with retail trading.

Identifying Retail Trading Dynamics for Alpha Generation

Before discussing how managers can adapt to the increased level in retail trading, we think it’s important to first discuss the tools and data available to managers that they use to form their market views. There is no consolidated feed that managers can subscribe to in order to easily obtain an overall view of retail trading for each stock, across different exchanges and brokerages, on a daily basis. For a manager to derive such a view is no easy task. Doing so often requires sophisticated technological capabilities combined with market expertise to successfully piece together an aggregate view on retail trading activities in a timely manner. Once this is achieved, managers can more effectively begin to think about any alpha generating signals or risk management initiatives related to retail trading.

The Equity Alpha team has developed several proprietary techniques based on market microstructures that enable the team to infer which trades may have been retail-initiated and whether it was a buy or a sell. Retail trades share certain identifiable characteristics, such as transaction sizes and execution methodologies. By examining trades for these types of characteristics, we can form our own views and estimates of the retail flow on any given day.

We also incorporate views from our signals that are specifically focused on capturing the latest trends in retail attention and sentiment. We search for datasets that are likely to be highly correlated with retail flow, or even better yet, may be predictive of future retail flow and retail attention. One type of dataset that we leverage is search interest for specific stock tickers on popular search engines. Other types of data, such as online forum comments or other social media postings, can help identify stocks that may be potentially the subject of the next retail frenzy.  

However, at the end of the day, we believe that it is important to make investment decisions that are based on a more holistic perspective that goes beyond just retail sentiment.

Implications for Risk Management

While the recent shifts in the makeup of market participants present opportunities for potential alpha generation, we are also very focused on the risk management implications of these shifting dynamics. Our approach seeks to capture both the stock-specific, idiosyncratic risk as well as how these “meme-stock” events manifest themselves through our factors.

We consistently monitor the holdings of our portfolios in order to identify any stocks that may be highly susceptible to extreme levels of retail attention. We focus primarily on the expression of excessive optimism given that retail investors tend to be more limited in their ability to express negative views on a stock due to the costs of short-selling. We also evaluate market-based metrics including the outstanding short interest, which is a measure of how many investors, primarily institutional, hold a short position in a name. Stocks with high short interest or a high rate of lending utilization may be more susceptible to experience a short squeeze. This combination of views helps inform the amount of risk we would want to allocate to a specific stock.

In regards to factor risk, we have seen consistent patterns in the types of aggregate exposures retail traders tend to take on, with one being higher volatility stocks. As retail traders tend to search for the next “lottery-ticket” name, they often prefer stocks that exhibit large moves in their stock price in hopes of larger payoffs.

Overall, our process seeks to balance how we capitalize on the potential opportunities that increased retail trading activity presents, and also remain vigilant risk management practitioners.



1Source: Goldman Sachs Global Markets Division. As of June 2021.

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Dennis Walsh

Dennis Walsh

Co-Head of Equity Alpha Strategies, Quantitative Investment Strategies, Goldman Sachs Asset Management

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