The mystery of the vanishing stock trader

The business of stock trading in Canada has shifted from roaring to boring in a matter of months, and no one is quite sure why.

What is certain is that for the first time in five years, the amount of stock changing hands in Canada is steadily dropping.

Between 2007 and early 2011, as stocks soared one year and plunged the next, one line on the graph was reasonably constant: The number of shares changing hands in Canada seemed to climb inexorably. In that time, the world endured the great financial crisis, the great rebound, the flash crash, and numerous days of huge ups and downs. Yet each year, the total volume of stock bought and sold in Canada jumped.

Starting about six months ago, that changed. Volumes slipped in summer as they always do, then just never came back. In the final months of 2010 and the first few months of 2011, total volume on all Canadian equity markets averaged about 26 billion shares a month. Since September, 2011, monthly volume has been more like 19 billion shares a month, a drop of roughly 27 per cent from the year-earlier period.

The full numbers aren't out for February, but there's no sign of letup. Volume on the Toronto Stock Exchange, still the busiest market in Canada, fell to eight billion shares in February from 9.3 billion in February, 2011.

It could be that Canadian investors suddenly and finally tired of the relentless volatility, or the long-term returns that have barely cracked positive territory.

Yet that explanation seems inadequate, given that, for years, volumes kept climbing – even as volatility soared and stocks moved up or down, sometimes by 5 per cent in one day. Yes, the final months of 2011 were hugely volatile, but so far in 2012 stock prices have generally been steadily climbing amid the lowest volatility in months. And all the while, trading volume is sagging.

Poll the traders at firms on Bay Street, and you get many theories about just which investors have stopped trading. Realistically, no one really knows. Traders only see the buy-and-sell traffic that crosses their own desks. Orders are not tagged in any way to identify what kind of investor is placing them.

But from anecdotal evidence, it's clear that almost every category of buyer and seller is backing off. As Doug Clark, head of research at brokerage firm ITG Canada puts it, "nobody is playing offence."

Retail investors, after gutting it out through years of awful returns, have finally fled. In a normal market, retail participation – Mr. and Mrs. Public trading their personal accounts – should be about 20 per cent. That plunged in November and December, traders say.

Professional portfolio managers are also sitting on their hands in cash, or moving to fixed-income or alternative investments. Take the Canada Pension Plan Investment Board as an example. In recent years, the pension fund manager has increased its holdings of bonds and what it calls inflation-sensitive assets (roads, bridges and other infrastructure). But its equity portfolio isn't much bigger than it was five years ago.

There's also the fact that regulation is becoming unfriendly, especially to hedge funds and proprietary traders. The amount of capital that banks can profitably hand to their trading desks to use is in decline.

Perhaps the most likely candidate for the drop-off is a decline in activity by the same high-frequency traders who helped boost volumes so dramatically in the preceding few years, and who now constitute roughly a third of the market by many estimates. So-called HFTs were drawn to Canada by incentives from markets such as the TSX, and by the opportunity to trade against investors big and small who weren't wise to their tricks.

The market is suddenly tougher for HFTs. Some strategies have become so competitive that they are less profitable, regulation is become steadily tougher on them, and Canadian investors who were easy pickings for HFTs have learned to deploy countermeasures.

For traders on Bay Street, there's no way to spin the declines as good news. Fewer shares changing hands mean fewer commissions, fewer jobs and smaller bonuses. It also translates to lower fees for the markets such as the TSX that process the trades.

From the perspective of investors, the ramifications are more ambiguous. A stock rally like the one Canada is currently enjoying looks dicey against a backdrop of falling volume.

But if the most predatory strategies of high-frequency traders are indeed on the wane, that's good news. And as any contrarian will tell you, when people give up on a market en masse, that's often the time to get in.