Nandini Sukumar:Increasing Market Participation-An Innovative Path for Exchanges

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The investment behavior of retail investors is a worldwide phenomenon observed in all markets across the globe, and is closely related to innovative developments and cross-border capital. Consequently, it is a crucial topic for all market participants to study the behavioral characteristics, trends and future prospects of retail investors. Over the past five years, there has been a significant increase in the participation of retail investors in financial markets globally, which has further grown during the epidemic period.

From a macro perspective, the average number of trades per month by retail investors at the beginning of 2016 was approximately 5 million. However, by 2019, the daily trading volume and the number of daily trades of retail investors have exponentially increased to 10 million. As of the end of 2020, the number of daily trades by retail investors has escalated to 30 million, which is five times greater than the figure recorded in 2016. During the epidemic, the growth in retail trading participation was particularly significant, with more than 70% of the 300 global exchanges witnessing a significant rise in retail participation.

These phenomena can be attributed to five factors:

The first is macroeconomic conditions. The impact of the epidemic reduced the willingness of institutional investors, while the risk of devaluation of national currencies with low interest rates prompted an increase in retail investments.

The second is new technologies that allow retail investors to participate more easily in market transactions.

The third is that lower transaction costs and higher volatility have provided opportunities for profit-taking.

The fourth is that retail investors in the midst of an epidemic of sequestration have more free time and more savings to trade more frequently and to use research and data as a guide to their investments.

The fifth is the development of convenient mobile trading software and social media.

From a global perspective, retail participation in financial markets is influenced by a range of factors. In the Asia Pacific and Middle East regions, retail participation levels are generally higher compared to other regions, but there is also a high degree of dispersion, making it challenging to draw definitive conclusions. While some exchanges in the Asia Pacific report over 80% retail participation, some individual markets in the region have only 20% retail participation, indicating scope for growth. In contrast, the level of retail trading in Europe, the US, and Africa is relatively low, and there is a need to explore strategies to promote retail participation in these regions.

A comparison of OECD member countries with similar economic and political characteristics reveals significant differences in the level of direct participation of residents in the stock market. North America, Northern Europe, and the Baltics have higher levels of market participation, with Estonia recording the highest level of retail investor participation.

Empirical analysis by the World Federation of Exchanges reveals that retail investors are influenced by market trends and performance. They trade more frequently when the market exhibits better return expectations, with every 1% increase in index returns leading to a 1.2% increase in trading volume and a 0.9% increase in trading volume per retail trading account. Retail trading also increases significantly during market volatility and downturns. Retail investors tend to buy when the market is under pressure, and their behavior is negatively correlated with the performance of the market index. This phenomenon is attributed to the behavioral biases of retail investors, such as loss aversion and regret aversion, which are typical traits of retail investment behavior.

There are a number of factors driving retail participation, with some available annual reports and related data being the main driver, as well as changes in the regulatory structure of the market, as well as lower brokerage fees, changes in tax laws, etc.

There are several drivers of retail participation, including annual reports and related data, regulatory changes in the market, lower brokerage fees, and changes in tax laws. Exchanges can play a key role in promoting retail participation through various means. The first is by enhancing financial literacy and education, while the second involves developing new financial products that provide liquidity and special fee structures for retail investors. Additionally, exchanges can offer positive incentives such as more favorable order processing rules for small, loose orders. Finally, operational tools such as market design and innovation can also be important. However, the most crucial factor is exchange-led financial literacy and education, coupled with the development of new products. Some exchanges have already implemented innovative measures to promote retail participation and have gained valuable experience in this area.

Several exchanges around the world have implemented various initiatives to promote retail trading.

In Mexico, for instance, exchanges have presented stock trading as a form of gaming through the media and focused on educating young people, including university students, about financial literacy.

Similarly, India has established a centralized digital market support platform and a simulation trading platform to help students and investors understand the concept of investing and practice hands-on exercises.

The Frankfurt Stock Exchange has set up a dedicated website that provides detailed product features, product search functions, and real-time market information. Additionally, by introducing the intraday Xetra Liquidity Measure (iXLM), investors can identify more favorable low-cost trading hours and reduce hidden transaction costs.

Nigerian exchanges have also been early adopters of retail participation, developing user-friendly mobile applications that link members’ trading pages and provide information such as savings, investments, market data, and news feeds.

Lastly, the Philippine stock exchange has a data analytics platform that facilitates investors’ access to data through analytics.

Global exchanges are increasingly using various strategies to promote retail participation in trading through market design. The Chicago Board Options Market, the largest options market in the world, has implemented a sophisticated trading feature called “Retail Priority,” which places retail investors’ orders at the front of orders at the same price level on a specific platform, enhancing trading quality. The U.S. financial markets, being typical and important, continuously promote retail participation in trading.

Current analysis shows that 68% of exchanges aim to attract more retail participation, a long-term trend that will become mainstream through sustained efforts to promote it. Meanwhile, 27% of exchanges intend to maintain current levels, and only 5% plan to decrease retail participation. From the exchange’s perspective, increasing retail participation is the primary trend in future financial markets.

The retail investment phenomenon will not subside, and retail investors will remain active, with the pandemic contributing to this trend in various ways. Retail investing is characterized by frequent trading, with investors reacting quickly to market changes, trading more after seeing high market returns and low market volatility. Retail investors may also act on cognitive biases, such as holding on to positions against market pressure. Thus, exchanges must prioritize consumer and investor rights protection, as well as education.

Having understood the global phenomenon and behavioral characteristics of retail investors, there are three important questions to consider:

First, what is the ideal level of retail investor participation?

Second, should retail investors be given access to more speculative and risky investment products?

Third, what is the ideal market structure for retail investors?

All three of these questions are shaping the feedback from public market exchanges on the behavior of retail traders, and they are certainly thinking about how to consistently include this segment of investors in the future.

Nandini Sukumar
Nandini Sukumar

Chief Executive Officer of the World Federation of Exchanges

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